<PAGE>
 
   As filed with the Securities and Exchange Commission on November 30, 1998
                                                    Registration No. 333-_______
================================================================================
                       SECURITIES AND EXCHANGE COMMISSION
                            WASHINGTON, D.C.  20549
                          ---------------------------
                                    FORM S-1
                             REGISTRATION STATEMENT
                                     UNDER
                           THE SECURITIES ACT OF 1933
                         -----------------------------

                            1ST STATE BANCORP, INC.
            (Exact name of registrant as specified in its charter)

<TABLE>
<S>                                 <C>                            <C>
            VIRGINIA                          6035                    [APPLIED FOR]
  (State or other jurisdiction      (Primary standard industrial     (I.R.S. employer
of incorporation or organization)    classification code number)   identification number)
</TABLE>

                              445 S. MAIN STREET
                       BURLINGTON, NORTH CAROLINA  27215
                                (336) 227-8861
         (Address, including zip code, and telephone number, including
            area code, of registrant's principal executive offices)

                                JAMES C. MCGILL
                     PRESIDENT AND CHIEF EXECUTIVE OFFICER
                            1ST STATE BANCORP, INC.
                              445 S. MAIN STREET
                       BURLINGTON, NORTH CAROLINA  27215
                                (336) 227-8861
           (Name, address, including zip code, and telephone number,
                  including area code, of agent for service)

                                  COPIES TO:
                          Gary R. Bronstein, Esquire
                          Joel E. Rappoport, Esquire
                      Housley Kantarian & Bronstein, P.C.
                       1220 19th Street, N.W., Suite 700
                            Washington, D.C.  20036

     APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC: As soon as
practicable after this registration statement becomes effective.

If any of the securities being registered on this form are to be offered on a
delayed or continuous basis pursuant to Rule 415 of the Securities Act of 1933,
check the following box: [_]

If this form is filed to register additional securities for an offering pursuant
to Rule 462(b) under the Securities Act, please check the following box and list
the Securities Act registration statement number of the earlier effective
registration statement for the same offering. [_]

If this form is a post-effective amendment filed pursuant to Rule 462(c) under
the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [_]

If delivery of the prospectus is expected to be made pursuant to Rule 434,
please check the following box. [_]

                        CALCULATION OF REGISTRATION FEE

<TABLE>
<CAPTION>
============================================================================================= 
   TITLE OF EACH CLASS       AMOUNT    PROPOSED MAXIMUM   PROPOSED MAXIMUM     AMOUNT OF
      OF SECURITIES          TO BE      OFFERING PRICE   AGGREGATE OFFERING   REGISTRATION
    TO BE REGISTERED       REGISTERED    PER SECURITY    OFFERING PRICE (1)       FEE
---------------------------------------------------------------------------------------------
<S>                        <C>         <C>               <C>                  <C>
Common Stock, par value
  $.01 per share.........   2,133,750     $  20.00       $   42,675,000       $  11,863.65
=============================================================================================
</TABLE>

(1)  Estimated solely for purposes of calculating the registration fee.

     THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR
DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL
FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION
STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(A) OF
THE SECURITIES ACT OF 1933 OR UNTIL THE REGISTRATION STATEMENT SHALL BECOME
EFFECTIVE ON SUCH DATE AS THE SECURITIES AND EXCHANGE COMMISSION, ACTING
PURSUANT TO SAID SECTION 8(A), MAY DETERMINE.
<PAGE>
 
PROSPECTUS
UP TO 2,133,750 SHARES OF COMMON STOCK
$20.00 PER SHARE
                                         1st STATE BANCORP, INC.
                                              445 S. MAIN STREET
                                              BURLINGTON, NORTH CAROLINA  27215
                                              (336) 227-8861
================================================================================
1st State Bank is converting from the mutual form to the stock form of
organization.  As part of the transaction,  1st State Bank will become a wholly
owned subsidiary of 1st State Bancorp, Inc., a corporation we recently formed
for the purpose of serving as our holding company.  As part of this process, we
are offering shares of 1st State Bancorp, Inc. common stock to the public.
Immediately following the completion of the Stock Conversion, we will convert to
a North Carolina commercial bank.
================================================================================
                             TERMS OF THE OFFERING

Ferguson & Company, an independent appraiser, has estimated the market value of
the converted 1st State Bank to be between $25,500,000 and $34,500,000, which
establishes the amount of stock to be sold.  Subject to regulatory approval, we
may increase the maximum amount offered by up to 15%.  Accordingly, at the
purchase price of $20.00 per share, we are offering a minimum of 1,275,000
shares and a maximum, as adjusted, of 1,983,750 shares.  Based on these
estimates, we are making the following offering of shares of common stock:

<TABLE>
<CAPTION>
                                                                 Per Share                   Total
                                                                 ---------                   -----
     <S>                                                         <C>                 <C>
     .    Purchase Price:  Minimum to Maximum, as adjusted       $20.00              $25,500,000 to $39,675,000
 
     .    Offering Expenses, Including Underwriting Discounts
          and Commissions: Minimum to  Maximum, as adjusted       $.77 to $.59        $978,000 to $1,173,000
 
     .    Net Proceeds to the Company:  Minimum to Maximum,       $19.23 to $19.41    $24,522,000 to $38,502,000
          as adjusted
</TABLE>

PLEASE REFER TO RISK FACTORS BEGINNING ON PAGE 1 OF THIS DOCUMENT.

These securities are not deposits or accounts and are not insured or guaranteed
by the FDIC or any other government agency.

Neither the Securities and Exchange Commission, the Administrator, the FDIC, nor
any state securities commission has approved or disapproved of these securities
or determined if this prospectus is truthful or complete.  Any representation to
the contrary is a criminal offense.

The common stock will be traded under the symbol "_____" on the Nasdaq National
Market.

The underwriters, Trident Securities, Inc., must sell the minimum number of
securities (1,275,000 shares of common stock) if any are sold.  The underwriters
are required to use only their best efforts to sell the maximum number of
securities offered (1,725,000 shares of common stock).

The Subscription Offering expires at 12:00 Noon Eastern Time, on __________,
1999, unless we extend it for up to 90 days.  We may terminate the Community
Offering at any time without notice.  Pending completion or termination of the
Offering, we will place funds for stock purchases in a segregated savings
account at 1st State Bank and we will pay interest at our passbook rate on funds
received for the period the funds are held until the completion or termination
of the Offering.

FOR INFORMATION ON HOW TO SUBSCRIBE, CALL THE STOCK INFORMATION CENTER AT (336)
___-____.

                            TRIDENT SECURITIES, INC.

                              ______________, 1999
<PAGE>
 
                       [INSIDE FRONT COVER OF PROSPECTUS]

                               TABLE OF CONTENTS
<TABLE>
<CAPTION>
 
                                                                                          Page
                                                                                          ----
<S>                                                                                       <C> 
Questions and Answers About the Conversion and the Offering ...........................    (i)
Summary................................................................................   (iv)
Selected Consolidated Financial Information and Other Data.............................  (vii)
Risk Factors...........................................................................     1
Proposed Management Purchases..........................................................     6
Use of Proceeds........................................................................     7
Dividend Policy........................................................................     7
Market for the Common Stock............................................................     8
Capitalization.........................................................................     9
Historical and Pro Forma Regulatory Capital Compliance.................................    11
Pro Forma Data.........................................................................    13
Comparison of Valuation and Pro Forma Information with No Foundation...................    16
The Conversion.........................................................................    17
Management's Discussion and Analysis of Financial Condition and Results of Operations..    34
Business of 1st State Bancorp, Inc.....................................................    48
Business of 1st State Bank.............................................................    49
Regulation.............................................................................    73
Taxation...............................................................................    82
Management of the Company..............................................................    83
Management of the Bank.................................................................    84
Certain Restrictions on Acquisition of the Company and the Converted Bank..............    92
Certain Anti-Takeover Provisions in the Articles of Incorporation and Bylaws...........    94
Description of Capital Stock...........................................................    99
Registration Requirements..............................................................   101
Legal Matters..........................................................................   101
Tax Opinions...........................................................................   101
Experts................................................................................   101
Additional Information.................................................................   101
Index to Consolidated Financial Statements.............................................   103
</TABLE>

       Please see the Glossary beginning on page A-1 for the meaning of
                              capitalized terms.
<PAGE>
 
                  QUESTIONS AND ANSWERS ABOUT THE CONVERSION
                               AND THE OFFERING

Q:   WHAT IS THE STOCK CONVERSION?

A:   The Stock Conversion is a change in our form of organization from mutual to
     stock form. Currently, we operate as a North Carolina-chartered mutual
     savings bank with no stockholders. As a result of the Stock Conversion, we
     will become a North Carolina-chartered stock savings bank. As part of our
     Stock Conversion, you may have the opportunity to become a stockholder of
     our newly formed holding company, 1st State Bancorp, Inc.

Q:   WHAT IS THE BANK CONVERSION?

A:   The Bank Conversion is the conversion of our charter from that of a North
     Carolina-chartered stock savings bank to that of a North Carolina-chartered
     commercial bank. The Bank Conversion will occur immediately following the
     completion of the Stock Conversion. We refer to the Stock Conversion and
     the Bank Conversion collectively as the "Conversion."

Q:   WHAT IS THE PURPOSE OF THE STOCK CONVERSION AND THE OFFERING?

A:   With the holding company structure, we will have the ability to plan and
     develop long-term growth opportunities and to access the capital markets
     more easily in the future. The Offering will increase our capital and the
     amount of funds available to us for lending and investment. This will give
     us greater flexibility to diversify operations and expand into other
     geographic markets, if we choose to do so. If our earnings are sufficient
     in the future, you might also receive dividends and benefit from the long-
     term appreciation of our stock price.

Q:   WHAT IS THE PURPOSE OF THE BANK CONVERSION?

A:   Conversion to a commercial bank charter will enable us to continue to
     pursue our expanding lines of business by increasing our investment in
     commercial real estate loans, commercial loans and consumer loans.

Q:   HOW DO I SUBSCRIBE FOR THE STOCK?

A:   You must complete and return the stock order form and certification form to
     us together with your payment or your authorization for withdrawal of the
     payment amount from an account you have with us, on or before 12:00 Noon on
     __________, 1999.

Q:   HOW MUCH STOCK MAY I PURCHASE?

A:   The minimum purchase is 25 shares (or $500). The maximum purchase per
     eligible depositor (which includes individuals on joint accounts or having
     the same address on our records) in the Subscription Offering is 50,000
     shares ($1,000,000). We may decrease or increase the maximum purchase
     limitation without notifying you.

     If shares are sold in a Community Offering (or a Syndicated Community
     Offering), the maximum number of shares that may be purchased by any party
     (which includes individuals on joint accounts or having the same address on
     our records) in the Community Offering (or a Syndicated Community
     Offering), when combined with the number of shares purchased by other
     parties with whom your shares may be aggregated is 50,000 shares
     ($1,000,000).

     Total purchases of stock in the Offering (i.e., combined purchases in the
     Subscription, Community and Syndicated Community Offerings) may not
     exceed $1,000,000.

                                      (i)
<PAGE>
 
Q:   WHAT HAPPENS IF THERE ARE NOT ENOUGH SHARES TO FILL ALL ORDERS?

A:   You might not receive any or all of the shares for which you subscribe. If
     orders are received for more shares than are available, the stock will be
     offered to the following persons or groups in order of priority.

     .  ELIGIBLE ACCOUNT HOLDERS - Depositors who had a deposit account with us
        on December 31, 1994 with a balance of at least $50.00. Any remaining
        shares will be offered to:

     .  OUR ESOP.  Any remaining shares will be offered to:

     .  SUPPLEMENTAL ELIGIBLE ACCOUNT HOLDERS - Depositors who had a deposit
        account with us on December 31, 1998 with a balance of at least $50.00.
        Any remaining shares will be offered to:

     .  OTHER MEMBERS - Other depositors and certain borrowers of ours, as of
        __________, 1999.

     If the above persons do not subscribe for all of the shares, the remaining
     shares will be offered to certain members of the general public with
     preference given to people who live in Alamance County, North Carolina.

Q.   WILL THE COMMON STOCK BE LISTED ON A STOCK EXCHANGE?

A.   Yes. We have received conditional approval for the common stock to be
     traded under the symbol "_____" on the Nasdaq National Market.

Q:   IS THE COMPANY'S COMMON STOCK INSURED BY THE FDIC?

A:   No. The Company's common stock is not a deposit or an account and is not
     insured or guaranteed by the FDIC or any other government agency.

Q:   WHAT PARTICULAR FACTORS SHOULD I CONSIDER WHEN DECIDING WHETHER OR NOT TO
     BUY THE STOCK?

A:   There are numerous risks associated with purchasing our stock. Before you
     decide to purchase stock, you should read this entire document, including
     the Risk Factors section beginning on page 1 of this document.

Q:   WILL THE CONVERSION AFFECT ANY DEPOSIT OR LOAN ACCOUNTS OR MY VOTING
     RIGHTS IN 1ST STATE BANK?

A:   Your deposit account, certificate accounts and any loans you may have with
     us will be not be affected by the Conversion or the Offering. Deposits will
     continue to be insured by the FDIC up to applicable limits. You presently
     have voting rights while we are in the mutual form; however, once we
     convert to the stock form all voting rights will belong to stockholders.
     You are not required to purchase stock.

Q:   WHO CAN ANSWER ANY OTHER QUESTIONS I MAY HAVE ABOUT THE CONVERSION AND
     THE OFFERING?

A:   In order to make an informed investment decision, you should read this
     entire document.  In addition, you may contact:


                           STOCK INFORMATION CENTER
                            1ST STATE BANCORP, INC.
                              445 S. MAIN STREET
                       BURLINGTON, NORTH CAROLINA  27215
                                (336) ___-____

                                     (ii)
<PAGE>
 
                   [MAP OF BANK'S MARKET AREA APPEARS HERE]

                                     (iii)
<PAGE>
 
                                    SUMMARY

       This summary highlights selected information from this document and may
not contain all the information that is important to you. To understand the
stock offering fully, you should read this entire document carefully, including
the consolidated financial statements and the notes to the consolidated
financial statements of 1st State Bank. References in this document to the
"Bank," "we," "us," and "our" refer to 1st State Bank. Where appropriate, "us"
or "our" refers collectively to 1st State Bancorp, Inc. and 1st State Bank.
References in this document to "the Company" refer to 1st State Bancorp, Inc.

1ST STATE BANCORP, INC.

       1st State Bancorp, Inc, was formed in November 1998 as a Virginia
corporation to be the holding company for 1st State Bank following the
Conversion. The Company is not an operating company and has not engaged in any
significant business to date. The holding company structure will provide greater
flexibility in terms of operations, expansion and diversification. See "The
Conversion -- Business Purposes."

       The Company's executive offices are located at 445 S. Main Street,
Burlington, North Carolina 27215, and its main telephone number is (336) 227-
8861.

1ST STATE BANK

       Founded in 1914, we are a community and customer oriented North Carolina-
chartered savings bank headquartered in Burlington, North Carolina. We have five
full service branch offices located in north central North Carolina on the
Interstate 85 corridor between the Piedmont Triad and Research Triangle. Our
primary market area consists of Alamance County, North Carolina.

       Our business consists principally of attracting deposits from the general
public and investing these funds in loans secured by single-family residential
and commercial real estate, secured and unsecured commercial loans and consumer
loans. Our profitability depends primarily on our net interest income, which is
the difference between the income we receive on our loan and investment
securities portfolios and our cost of funds, which consists of interest paid on
deposits and borrowed funds. We also earn income from miscellaneous fees related
to our loans and deposits, mortgage banking income and commissions from sales of
annuities and mutual funds. At September 30, 1998, we had total assets of $288.2
million, deposits of $235.7 million and total net worth of $26.0 million.

       Our executive offices are located at 445 S. Main Street, Burlington,
North Carolina 27215, and our main telephone number is (336) 227-8861.

       After completion of the Bank Conversion, we will be a North Carolina-
chartered commercial bank, and we will retain our current name "1st State Bank."
As a commercial bank, we intend to continue to follow our same business
strategies and will be subject to the regulation and supervision of the FDIC and
the Commission. See "The Conversion --Business Purposes."

THE CONVERSION

       The Conversion consists of the Stock Conversion followed immediately by
the Bank Conversion. Pursuant to the Stock Conversion, we will convert from
mutual to stock form and will become a wholly owned subsidiary of the Company.
Pursuant to the Bank Conversion, we will convert to a North Carolina-chartered
commercial bank and will remain a wholly owned subsidiary of the Company.

                                     (iv)
<PAGE>
 
THE OFFERING

       As part of the Stock Conversion, the Company is offering between
1,275,000 and 1,725,000 shares of common stock at $20.00 per share. Subject to
regulatory approval, the number of shares to be sold may be increased to
1,983,750 shares without any further notice to you if market or financial
conditions change prior to the completion of the Stock Conversion.

       The Company is first offering its shares of common stock in a
Subscription Offering. Depositor and borrower members as of certain eligibility
dates will receive subscription rights. The shares of common stock will be
offered on the basis of priorities. Any remaining shares may be offered in a
Community Offering or in a Syndicated Community Offering. See "The Conversion --
Subscription Rights."

CHARITABLE FOUNDATION

       In furtherance of our long-standing commitment to our local community, we
will establish a charitable foundation which will be dedicated to charitable and
community service causes within our market area. In connection with the Stock
Conversion, we will contribute up to 150,000 shares of common stock to fund the
Foundation's operations. We expect to realize an after-tax expense of $2.0
million during the quarter ended March 31 or June 30, 1999 as a result of our
contribution to the Foundation. See "Risk Factors -- The Expense and Dilutive
Effect of the Contribution of Shares to the Charitable Foundation" and "The
Conversion -- Establishment of the Foundation."

SUBSCRIPTION RIGHTS ARE NOT TRANSFERABLE

       You may not assign or sell your subscription rights. Any transfer of
subscription rights is prohibited by law. If you exercise subscription rights,
you will be required to certify that you are purchasing shares solely for your
own account and that you have no agreement or understanding regarding the sale
or transfer of shares. We intend to pursue any and all legal and equitable
remedies in the event that we become aware of the transfer of any subscription
rights. We will reject orders that we determine to involve the transfer of
subscription rights.

THE OFFERING RANGE AND DETERMINATION OF THE PRICE PER SHARE

       The offering range is based on an independent appraisal of the pro forma
market value of the Converted Bank by Ferguson, an appraisal firm experienced in
appraisals of savings institutions. The pro forma market value is our estimated
market value after giving effect to the sale of shares in this Offering.
Ferguson has estimated that in its opinion as of October 30, 1998 the value
ranged between $25.5 million and $34.5 million (with a midpoint of $30.0
million). We refer to this range as the "Estimated Valuation Range." The
appraisal was based in part upon our financial condition and operations and the
effect of additional capital raised by the sale of common stock in this
Offering. The $20.00 price per share was determined by our Board of Directors.
Subject to regulatory approval, an amount of common stock up to 15% above the
maximum of the Estimated Valuation Range may be offered. We are offering a
minimum of 1,275,000 shares of common stock and a maximum, as adjusted of
1,983,750 shares of common stock. The appraisal will be updated prior to the
completion of the Stock Conversion. If the pro forma market value of the common
stock at that time is either below $25.5 million or above $39.7 million, we will
notify you and you will have the opportunity to modify or cancel your order. See
"The Conversion -- Stock Pricing and Number of Shares to be Issued."

                                      (v)
<PAGE>
 
TERMINATION OF THE STOCK OFFERING

       The Subscription Offering will terminate at 12:00 Noon, Eastern Time, on
__________, ___________, 1999. The Community Offering and Syndicated Community
Offering, if any, may terminate at any time without notice but will terminate no
later than __________, 1999, without approval of the Administrator and the FDIC.

BENEFITS TO MANAGEMENT FROM THE OFFERING

       Our full-time employees will participate in the Offering through the
purchase of stock by our ESOP, which is a form of retirement plan. Following the
Conversion, we also intend to implement a restricted stock plan and a stock
option plan, which will benefit our officers and directors. These plans will not
be adopted until at least six months after the Stock Conversion. If we adopt a
restricted stock plan, our executive officers and directors will be awarded
shares of common stock at no cost to them. See "Management of the Bank --
Proposed Future Stock Benefit Plans."

USE OF PROCEEDS FROM THE SALE OF THE COMMON STOCK

       We will use the net proceeds from the Offering as follows. The
       percentages we use are estimates:

       .   50% will be invested in the Bank by buying all the capital stock of
           the Converted Bank

       .   8% will be loaned to our employee stock ownership plan to fund its
           purchase of common stock

       .   42% will be retained for other general corporate purposes, and may be
           used as a possible source of funds for the payment of dividends to
           stockholders or the repurchase of stock.

       The proceeds to be received by the Bank will be available for general
corporate purposes, including the continued expansion of our retail banking
franchise through continued growth in the loan portfolio, the opening of new
branches, deposit or bank acquisitions, and the purchase of investment
securities. See "Use of Proceeds."

DIVIDENDS

       We intend to pay an annual cash dividend of $.40 per share, payable
quarterly at $.10 per share. The payment of dividends is expected to commence
following the first full quarter after completion of the Offering. For a
discussion of our anticipated dividend policy, including restrictions on our
ability to pay dividends, see "Dividend Policy."

MARKET FOR THE COMMON STOCK

       We have received conditional approval to list the common stock on the
Nasdaq National Market under the symbol "_____".  See "Market for the Common
Stock."

RISKS IN OWNING THE COMMON STOCK

       Before you decide to purchase stock in the Offering, you should read this
entire document, including the Risk Factors section beginning on page 1 of
this document.

       The shares of common stock we are offering:

       .   Are not deposit accounts;

       .   Are not insured or guaranteed by the FDIC or any other government
           agency; and

       .   Are not guaranteed by us.

       The common stock is subject to investment risk, including the possible
  loss of principal invested.

                                     (vi)
<PAGE>
 
          SELECTED CONSOLIDATED FINANCIAL INFORMATION AND OTHER DATA


     The following summary consolidated financial information is derived from
our audited consolidated financial statements at the dates and for each of the
fiscal years shown below. The following information is only a summary and you
should read it in conjunction with our consolidated financial statements and the
notes to our consolidated financial statements, which you can find beginning on
page F-1 of this Prospectus.

SELECTED FINANCIAL CONDITION DATA

<TABLE>
<CAPTION>
                                                                         At September 30,
                                                         ------------------------------------------------
                                                           1998      1997      1996      1995      1994
                                                         --------  --------  --------  --------  --------
                                                                              (In thousands)
<S>                                                      <C>       <C>       <C>       <C>       <C>
Total assets.........................................    $288,223  $258,509  $235,138  $222,916  $208,332         
Loans receivable.....................................     196,782   197,122   173,849   171,093   154,195         
Loans held for sale, at lower of cost or fair value..       7,540       684     2,377        --        --         
Cash and cash equivalents............................      31,077    14,990     9,754     7,550     4,858         
Investment securities:                                                                                            
  Available for sale.................................       9,858    11,320    16,024    16,307    19,004         
  Held to maturity...................................      30,195    23,482    21,685    17,649    18,197         
Deposit accounts.....................................     235,694   229,341   209,707   200,769   188,309         
Advances from Federal Home Loan Bank.................      20,000     1,000     1,000        --     1,000         
Net worth (1)........................................      25,966    23,277    20,629    19,151    16,530         
</TABLE>

__________
(1)       Consists of retained income, substantially restricted, and net
          unrealized gains or losses on securities available for sale.


SELECTED OPERATING DATA

<TABLE> 
<CAPTION>  
                                                                     Year Ended September 30,           
                                                         -----------------------------------------------
                                                           1998      1997      1996      1995     1994  
                                                         -------   -------   -------   -------   -------
                                                                    (In thousands)                  
<S>                                                      <C>       <C>       <C>       <C>       <C>       
Total interest income................................    $20,708   $19,061   $17,395   $16,146   $13,374   
Total interest expense...............................     11,071     9,799     9,453     8,584     7,175   
                                                         -------   -------   -------   -------   -------   
Net interest income..................................      9,637     9,262     7,942     7,562     6,199   
Provision for loan losses............................        477       261       281       454       240   
                                                         -------   -------   -------   -------   -------   
Net interest income after provision                                                                        
 for loan losses.....................................      9,160     9,001     7,661     7,108     5,959   
Other income.........................................      1,497     1,468     1,179     1,600       295   
Operating expenses...................................      6,774     6,473     6,403     5,006     4,316   
                                                         -------   -------   -------   -------   -------    
Income before income taxes...........................      3,883     3,996     2,437     3,702     1,938    
Income taxes.........................................      1,362     1,447       841     1,378       686    
                                                         -------   -------   -------   -------   -------    
Net income...........................................    $ 2,521   $ 2,549   $ 1,596   $ 2,324   $ 1,252    
                                                         =======   =======   =======   =======   =======     
</TABLE>

                                     (vii)
<PAGE>
 
SELECTED FINANCIAL RATIOS AND OTHER DATA

<TABLE>
<CAPTION>
                                                                        At or for the
                                                                   Year Ended September 30,
                                                        -------------------------------------------------
                                                          1998       1997      1996     1995      1994
                                                        -------    -------   -------  -------   --------
<S>                                                     <C>        <C>        <C>      <C>      <C>
PERFORMANCE RATIOS:
 Return on average assets (net income divided
   by average total assets)...........................      0.92%      1.03%    0.70%    1.07%      0.60%       
 Return on average net worth (net income                                                                        
   divided by average net worth)......................     10.20      11.34     7.92    12.94       7.75        
 Interest rate spread (combined weighted average                                                                
   interest rate earned less combined weighted                                                                  
   average interest rate cost)........................      3.45       3.70     3.41     3.45       3.06        
 Net interest margin (net interest income divided by                                                            
   average interest-earning assets)...................      3.77       4.00     3.68     3.68       3.20        
 Ratio of average interest-earning assets                                                                       
   to average interest-bearing liabilities............    107.42     106.99   106.25   105.61     103.88        
 Ratio of operating expenses to average total assets..      2.48       2.62     2.80     2.30       2.07         
 
ASSET QUALITY RATIOS:
 Nonperforming assets to total assets
   at end of period...................................      0.09       0.10     0.12     1.64       1.58       
 Nonperforming loans to total loans                                                                            
   at end of period...................................      0.13       0.13     0.16     2.11       0.06       
 Allowance for loan losses to total                                                                            
   loans at end of period.............................      1.61       1.38     1.42     1.28       1.13       
 Allowance for loan losses to nonperforming                                                                    
   loans at end of period.............................  1,227.38   1,063.32   866.67    60.72   1,784.85       
 Provision for loan losses to total loans.............      0.24       0.13     0.16     0.26       0.15       
 Net charge-offs to average loans                                                                              
   outstanding........................................        --         --       --       --       0.01       
                                                                                                               
CAPITAL RATIOS:                                                                                                
 Net worth to total assets at                                                                                  
   end of period......................................      9.01       9.00     8.77     8.59       7.93       
 Average net worth to average assets..................      9.05       9.10     8.80     8.25       7.75        
</TABLE> 
 

<TABLE> 
<CAPTION> 
                                                                           At September 30,
                                                        -----------------------------------------------
                                                           1998       1997     1996     1995     1994
                                                         -------    -------   ------   ------   -------
<S>                                                     <C>        <C>        <C>      <C>      <C>          
Number of:
  Loans outstanding...................................     6,253      6,410    6,404    6,675     6,848     
  Deposit accounts....................................    26,066     26,924   27,187   27,850    27,399     
  Offices open (1)....................................         6          6        6        5         5     
</TABLE>

___________
(1)  All offices are full service offices.

                                    (viii)
<PAGE>
 
                                  RISK FACTORS

       IN ADDITION TO THE OTHER INFORMATION IN THIS DOCUMENT, YOU SHOULD
  CONSIDER CAREFULLY THE FOLLOWING RISK FACTORS IN DECIDING WHETHER TO INVEST IN
  THE COMMON STOCK.  CERTAIN STATEMENTS IN THIS DOCUMENT ARE FORWARD-LOOKING AND
  ARE IDENTIFIED BY THE USE OF FORWARD-LOOKING WORDS OR PHRASES SUCH AS
  "INTENDED," "WILL BE POSITIONED," "EXPECTS," IS OR ARE "EXPECTED,"
  "ANTICIPATES," AND "ANTICIPATED" AND OTHER WORDS AND PHRASES OF SIMILAR
  MEANING.  THESE FORWARD-LOOKING STATEMENTS ARE BASED ON OUR CURRENT
  EXPECTATIONS.  TO THE EXTENT ANY OF THE INFORMATION CONTAINED IN THIS DOCUMENT
  CONSTITUTES A FORWARD-LOOKING STATEMENT, THE RISK FACTORS SET FORTH BELOW ARE
  CAUTIONARY STATEMENTS IDENTIFYING IMPORTANT FACTORS THAT COULD CAUSE ACTUAL
  RESULTS TO DIFFER MATERIALLY FROM THOSE IN THE FORWARD-LOOKING STATEMENT.

  RISKS RELATED TO COMMERCIAL AND CONSUMER LENDING

       We generally invest a greater proportion of our assets in loans secured
  by commercial real estate, commercial loans and consumer loans than typical
  savings institutions that invest a greater proportion of their assets in loans
  secured by single-family residences.  At September 30, 1998, commercial real
  estate, commercial loans and consumer loans totaled $38.8 million, $25.2
  million and $6.3 million, respectively, which represented 18.8%,12.2% and
  3.1%, respectively, of gross loans.  At September 30, 1998, $100.9 million, or
  48.8% of gross loans, consisted of residential real estate mortgage loans.
  Our business plan calls for continued efforts to increase the percentage of
  our assets invested in commercial real estate loans, commercial loans and
  consumer loans.

       Commercial real estate loans and commercial loans generally involve a
  higher degree of credit risk than residential mortgage lending due primarily
  to the large amounts loaned to individual borrowers.  At September 30, 1998,
  our ten largest lending relationships ranged in size from $2.4 million to $4.3
  million.  Losses incurred on loans to a small number of borrowers could have a
  material adverse impact on our income and financial condition.  In addition,
  unlike residential mortgage loans,  commercial and commercial real estate
  loans depend on the cash flow from the property or the business to service the
  debt.  Cash flow may be significantly affected by general economic conditions.
  Consumer lending is riskier than residential mortgage lending because consumer
  loans are either unsecured or secured by assets that depreciate in value.

  POTENTIALLY ADVERSE IMPACT OF INTEREST RATES

       Our ability to earn a profit, like that of most financial institutions,
  is substantially dependent on our net interest income, which is the difference
  between the interest income we earn on our interest-earning assets (such as
  mortgage loans and investments) and the interest expense we pay on our
  interest-bearing liabilities (such as deposits).  Our profitability depends on
  our ability to manage our assets and liabilities during periods of changing
  market interest rates.  A sustained decrease in market interest rates could
  adversely affect our earnings.

       Changes in interest rates also can affect the average life of loans and
  investment securities.  When interest rates decline, borrowers tend to
  refinance higher-rate, fixed-rate loans at lower rates.  Under those
  circumstances, we would not be able to reinvest those prepayments in assets
  earning interest rates as high as the rates on the prepaid loans or investment
  securities.  As a result our interest income could decline.

  ANTICIPATED LOW RETURN ON EQUITY FOLLOWING CONVERSION

       Return on average equity (net income divided by average equity) is a
  ratio used by many investors to compare the performance of a financial
  institution to its peers.  As a result of the Conversion, our equity will
  increase substantially.  Our expenses also will increase due to added expense
  associated with our employee stock ownership plan and, later on, our
  restricted stock plan, as well as with the costs of being a public company.
  Because of the increases in our equity and expenses, until we are able to
  increase our balance sheet by adding loans and deposits, thereby 

                                       1
<PAGE>
 
  increasing net interest income, we expect our return on equity to decrease as
  compared to our performance in previous years.

  UNCERTAINTY AS TO EXISTENCE OF GROWTH OPPORTUNITIES

       To fully use capital raised in the Offering, if sufficient growth
  opportunities are not available in our market area, we may seek to expand into
  suitable market areas by either establishing one or more new branches or by
  acquiring another financial institution or branches of another financial
  institution.  Our ability to establish new branch offices depends on whether
  we can identify advantageous branch office locations and generate new deposits
  and loans from those locations that will create an acceptable level of net
  income.  New branches also typically entail start-up expenses.  Our ability to
  acquire other financial institutions or branches depends on whether we can
  identify, acquire and integrate such institutions or branches.  We cannot
  assure you that we will be able to generate growth or identify attractive
  acquisition candidates, acquire such candidates on favorable terms or
  successfully integrate any acquired institutions or branches.

  THE EXPENSE AND DILUTIVE EFFECT OF THE CONTRIBUTION OF SHARES TO THE
  CHARITABLE FOUNDATION

       We are establishing a charitable foundation in connection with the Stock
  Conversion and  contributing up to 150,000 shares of common stock to the
  Foundation.  The contribution to the Foundation will reduce our earnings in
  1999, the fiscal year in which the Foundation is to be established and the
  contribution made, by up to $2.0 million.  If the Foundation had been
  established and the contribution made during the year ended September 30,
  1998, we would have reported net income of approximately $541,000 rather than
  reporting net income of approximately $2.5 million, for the year ended
  September 30, 1998.  In addition, due to the contribution of shares to the
  Foundation, persons purchasing shares in the Offering will have their
  ownership and voting interests in the Company diluted.  The number of shares
  of common stock to be contributed to the Foundation will equal between 7.0%
  and 10.5% of the shares that will be outstanding following the Conversion at
  the maximum, as adjusted and minimum, respectively, of the Estimated Valuation
  Range.  See "The Conversion -- Establishment of the Charitable Foundation."

  DEPENDENCE ON MARKET AREA

       Our market area consists of Alamance County in North Carolina.  We
  estimate that more than 90% of deposits and loans come from our market area.
  Despite recent diversification, the economy in Alamance County continues to be
  heavily dependent on the textile industry.  A downturn in the textile industry
  could adversely affect the economy in Alamance County, which could adversely
  affect our earnings and reduce the demand for loans and deposits.

  STRONG COMPETITION WITHIN OUR MARKET AREA

       Competition in the banking and financial services industry is intense.
  We compete with commercial banks, savings and loan associations, credit
  unions, finance companies, mutual funds, insurance companies, and brokerage
  and investment banking firms.  Many of these competitors have substantially
  greater resources and lending limits than we do and may offer certain services
  that we do not or cannot provide.  Our profitability depends upon our
  continued ability to successfully compete.

  ANTI-TAKEOVER PROVISIONS AND STATUTORY PROVISIONS THAT COULD DISCOURAGE
  HOSTILE ACQUISITIONS OF CONTROL

       Provisions in the Company's Articles of Incorporation and Bylaws, the
  Virginia Stock Corporation Act, and certain federal regulations may make it
  difficult, and expensive, to pursue a tender offer, change in control or
  takeover attempt that our Board of Directors opposes.  As a result, you may
  not have an opportunity to participate in such a transaction.  Such provisions
  will also render the removal of our current Board of Directors or management
  more difficult.  In addition, these provisions may reduce the trading price of
  our stock.  These provisions include:  restrictions on the acquisition of the
  Company's equity securities and limitations on voting rights; the
  classification of the terms of 

                                       2
<PAGE>
 
  the members of the Board of Directors; certain provisions relating to meetings
  of stockholders; denial of cumulative voting by stockholders in the election
  of directors; the possible issuance of preferred stock and additional shares
  of common stock without shareholder approval; and super-majority provisions
  for the approval of certain business combinations. See "Certain Restrictions
  on Acquisition of the Company and the Converted Bank."

  POSSIBLE VOTING CONTROL BY DIRECTORS AND OFFICERS

       The proposed purchases of common stock by our directors and officers, our
  ESOP and our restricted stock plan, if implemented (estimated to be
  approximately 635,500 shares, or 38.5% of the shares to be sold at the
  midpoint of the Estimated Valuation Range), as well as the potential
  acquisition of common stock through stock benefit plans, could make it
  difficult to obtain majority support for stockholder proposals which are
  opposed by management.  In addition, the voting of those shares could enable
  management to block the approval of transactions (i.e., business combinations
  and amendments to our Articles of Incorporation and Bylaws) requiring the
  approval of 80% of the stockholders.  See "Management of the Bank -- Executive
  Compensation -- Employee Stock Ownership Plan," " -- Proposed Future Stock
  Benefit Plans -- Stock Option Plan," " -- Management Recognition Plan,"
  "Description of Capital Stock" and "Certain Restrictions on Acquisition of the
  Company and the Converted Bank."

  POTENTIAL COST OF  FUTURE EMPLOYEE STOCK BENEFIT PLANS

       It is anticipated that the ESOP will purchase 8% of the common stock
  issued in the Stock Conversion, including shares contributed to the
  Foundation, with funds borrowed from the Company.  The cost of acquiring the
  ESOP shares will be between $2.3 million, and $3.4 million.  We will record
  annual ESOP expenses in an amount equal to the fair value of shares committed
  to be released to employees.  If shares of common stock appreciate in value
  over time, compensation expense relating to the ESOP may increase.  In
  addition, it is possible that we will implement a restricted stock plan, under
  which officers and directors could be awarded (at no cost to them) up to an
  aggregate of 4% of the shares issued in the Stock Conversion, including shares
  contributed to the Foundation.  Assuming the shares of common stock to be
  awarded under the plan cost the Purchase Price of $20.00 per share, the
  reduction to stockholders' equity of funding the plan would be between $1.1
  million and $1.7 million.

  POSSIBLE DILUTIVE EFFECT OF EMPLOYEE STOCK BENEFIT PLANS

       If the Conversion is completed and stockholders subsequently approve a
  restricted stock plan and a stock option plan, we will issue stock to our
  officers and directors through these plans.  If the shares for the restricted
  stock plan are issued from our authorized but unissued stock, your ownership
  percentage could be diluted by up to approximately 4% and the trading price of
  our stock may be reduced.  See "Pro Forma Data," "Management of the Bank --
  Proposed Future Stock Benefit Plans -- Stock Option Plan," and "-- Management
  Recognition Plan."  These plans will also involve additional expense.  See "--
  Anticipated Low Return on Equity Following Conversion."

  VALUATION NOT INDICATIVE OF FUTURE PRICE OF COMMON STOCK

       The final aggregate purchase price of the common stock in the Stock
  Conversion will be based upon an independent appraisal. The appraisal is not
  intended, and should not be construed, as a recommendation of any kind as to
  the advisability of purchasing shares of common stock. The valuation is based
  on estimates and projections of a number of matters, all of which are subject
  to change from time to time. We cannot assure you that if you purchase common
  stock in the Offering for $20.00 per share you will later be able to sell it
  at or above that price. See "The Conversion -- Stock Pricing and Number of
  Shares to be Issued."

                                       3
<PAGE>
 
  POSSIBLE ADVERSE TAX CONSEQUENCES OF THE SUBSCRIPTION RIGHTS

       Should the IRS determine that the subscription rights have ascertainable
  value, you could be taxed as a result of your exercise of such rights in an
  amount equal to such value.  We have received the opinion of Ferguson that the
  subscription rights granted to eligible members in connection with the Stock
  Conversion have no value.  This opinion is not binding on the Internal Revenue
  Service ("IRS"), however.

  RECENT STOCK MARKET VOLATILITY

       Publicly traded stocks, including stocks of financial institutions, have
  recently experienced substantial market price volatility.  These market
  fluctuations may be unrelated to the operating performance of particular
  companies whose shares are traded.  In several cases, common stock issued by
  recently converted financial institutions has traded at a price that is below
  the price at which such shares were sold in the initial offerings of those
  companies.  The purchase price of our common stock in the offering is based on
  the independent appraisal by Ferguson.  After our shares begin trading, the
  trading price of our common stock will be determined by the marketplace, and
  may be influenced by many factors, including prevailing interest rates,
  investor perceptions of the Company and general industry and economic
  conditions.  Due to possible continued market volatility and to other factors,
  including certain Risk Factors discussed in this document, there can be no
  assurance that, following the Stock Conversion, the trading price of our
  common stock will be at or above the $20.00 per share initial offering price.

  NO OPINION OR RECOMMENDATION BY SALES AGENT; BEST EFFORTS OFFERING

       We have engaged Trident Securities to consult with and advise us with
  respect to the Stock Conversion and to assist, on a best-efforts basis, in
  connection with the solicitation of subscriptions and purchase orders for
  shares of common stock in the Offering.  Trident Securities has not prepared
  or delivered any opinion or recommendation with respect to the suitability of
  the common stock or the appropriateness of the amount of common stock to be
  issued in the Stock Conversion.  The engagement of Trident Securities by us
  and the work performed pursuant to such engagement, including any due
  diligence investigation, should not be construed by purchasers of the common
  stock as constituting an opinion or recommendation relating to investment in
  the common stock offered by this document.

  IMPACT OF TECHNOLOGICAL ADVANCES; YEAR 2000 COMPLIANCE

       Our industry is experiencing rapid changes in technology.  Technology-
  driven products and services are frequently introduced.  In addition to
  improving customer services, effective use of technology increases efficiency
  and enables financial institutions to reduce costs.  Our future success will
  thus depend partly on our ability to address our customers' needs by using
  technology.  Many of our competitors have far greater resources than we have
  to invest in technology.  We cannot assure you that we will be able to
  effectively develop new technology-driven products and services or be
  successful in marketing these products to our customers.

       Our operations are also dependent on computers and computer systems,
  whether we maintain them internally or they are maintained by a third party.
  Systems that do not properly recognize the correct year could produce faulty
  data or cause a system to fail.  Such failures may include, among other
  things, the inability to process and underwrite loan applications, to credit
  deposits and withdrawals from customer accounts, to credit loan payments or
  track delinquencies, to properly reconcile and record daily activity or to
  engage in similar normal banking activities.  Additionally, if our commercial
  customers are not Year 2000 compliant and suffer adverse effects on their
  operations, their ability to meet their obligations to us could be adversely
  affected.   We cannot assure you that we, our customers and our third party
  providers will be successful in making all necessary changes to avoid computer
  system failures related to the year 2000.  For a further discussion of our
  efforts to prepare for Year 2000 issues, see "Management's Discussion and
  Analysis of Financial Condition and Results of Operations -- Year 2000
  Compliance."

                                       4
<PAGE>
 
  EFFECT OF REGULATORY CHANGES ON OPERATIONS

       We are subject to extensive regulation, supervision and examination by
  the Administrator and the FDIC.  Following the Conversion, the Converted Bank
  will be subject to the regulation and supervision of the Commission and the
  FDIC, and the Company will be subject to regulation and supervision by the
  Federal Reserve Board.  The regulatory authorities have extensive discretion
  in connection with their supervisory and enforcement activities.  Any change
  in regulation, whether by the Commission, the FDIC, the Federal Reserve Board
  or the U.S. Congress, could have a significant impact on us and our
  operations.

       There is legislation pending in the U.S. Congress that calls for the
  modernization of the banking system and that would significantly affect the
  operations and regulatory structure of the financial services industry.   At
  this time, we do not know what form the final legislation might take, but if
  enacted into law, the legislation could affect our competitive environment as
  well as our business and operations.  See "Regulation --Depository Institution
  Regulation -- Proposed Legislative and Regulatory Changes."

  RISK OF LOSS OF PRINCIPAL

       The shares of common stock offered by this document are not savings
  accounts or deposits and are not insured or guaranteed by the FDIC, the SAIF
  or any other governmental agency, and involve investment risk, including the
  possible loss of principal.

                                       5
<PAGE>
 
                         PROPOSED MANAGEMENT PURCHASES

       The following table sets forth the approximate purchases of common stock
  by each director and executive officer and their associates.  The table
  assumes that 1,500,000 shares of the common stock, the midpoint of the
  Estimated Valuation Range, will be sold at $20.00 per share, that 150,000
  shares are issued to the Foundation and that sufficient shares will be
  available to satisfy subscriptions in all categories.

<TABLE>
<CAPTION>
                                                                    Percent       Aggregate Purchase
                                                         Total      of Total           Price of
Name and Position                                        Shares   Outstanding (1)  Proposed Purchases
-----------------                                        -------  ---------------  ------------------
<S>                                                      <C>      <C>              <C>
  James A. Barnwell, Jr., Director                        50,000       3.0%         $ 1,000,000
  Bernie C. Bean, Director                                25,000       1.5              500,000
  Richard C. Keziah, Chairman of the Board                47,500       2.9              950,000
  James G. McClure, Director                              50,000       3.0            1,000,000
  James C. McGill, President, Chief Executive             50,000       3.0            1,000,000
      Officer and Director
  T. Scott Quakenbush, Director                           50,000       3.0            1,000,000
  Richard H. Shirley, Director                            37,500       2.3              750,000
  Virgil L. Stadler, Director                             50,000       3.0            1,000,000
  A. Christine Baker, Executive Vice President-
      Chief Financial Officer                             32,500       2.0              650,000
  Fairfax C. Reynolds, Executive Vice President-
     Commercial & Retail Banking                          32,500       2.0              650,000
  John D. Hansell, Manager-First Capital Services LLC      2,500        .2               50,000
  Frank Gavigan, Senior Vice President-Senior             10,000        .6              200,000
    Credit Officer
 
  All directors and executive officers, as a
    group (12 persons) and their associates              437,500      26.5            8,750,000
 
  ESOP                                                   132,000       8.0            2,640,000
  MRP  (2)                                                66,000       4.0            1,320,000
                                                         -------      ----          -----------
       Total (3)                                         635,500      38.5%         $12,710,000
                                                         =======      ====          ===========
</TABLE> 

____________________
(1)  Percentages are based on the sale of 1,500,000 shares at the midpoint of
     the Estimated Valuation Range and the issuance of 150,000 shares to the
     Foundation.

(2)  Consists of shares that are expected to be awarded to participants in the
     MRP, if implemented. The dollar amount of the common stock to be purchased
     by the MRP is based on the Purchase Price in the Offering and does not
     reflect possible future increases or decreases in the value of such stock.
     See "Management of the Bank -- Proposed Future Stock Benefit Plans --
     Management Recognition Plan." Such shares could be newly issued shares or
     shares purchased in the open market in the sole discretion of the Company's
     Board of Directors. The percentage shown assumes the shares are purchased
     in the open market. Any sale of newly issued shares to the MRP would be
     dilutive to existing stockholders. See "Risk Factors -- Possible Dilutive
     Effect of Future Employee Stock Benefit Plans."

(3)  Does not include shares that possibly would be purchased by participants in
     a stock option plan, intended to be implemented, under which directors,
     executive officers and other employees would be granted options to purchase
     an aggregate amount of common stock equal to 10% of the shares issued in
     the Stock Conversion, including shares contributed to the Foundation at
     exercise prices equal to the market price of the common stock on the date
     of grant. See "Management of the Bank --Proposed Future Stock Benefit 
     Plans -- Stock Option Plan."

                                       6
<PAGE>
 
                                USE OF PROCEEDS

       The net proceeds from the sale of the common stock are estimated to be
  between $24.5 million at the minimum of the Offering range, and $38.5 million
  at the maximum, as adjusted of the Offering range.  The Company will purchase
  all of the capital stock of the Converted Bank in exchange for 50% of the net
  proceeds after deducting the cost of the ESOP loan.  Assuming the sale of
  $30.0 million of common stock at the midpoint of the Estimated Valuation Range
  and the purchase of 8% of the shares to be issued in the Stock Conversion,
  including shares contributed to the Foundation, by the ESOP, the Bank would
  receive approximately $13.2 million in cash, and the Company would retain
  approximately $13.2 million in cash and $2.6 million in the form of a note
  receivable from the ESOP.

       The proceeds retained by the Company, after making the loan to the ESOP,
  initially will be invested in short-term and intermediate-term securities,
  including cash and cash equivalents and U.S. Government and agency
  obligations.  The proceeds will be available for a variety of corporate
  purposes, including funding a restricted stock plan, if implemented, future
  acquisitions and diversification of business, additional capital contributions
  to the Converted Bank, dividends to stockholders and future repurchases of
  common stock.  We do not have any specific plans, intentions, arrangements or
  understandings regarding acquisitions, capital contributions or repurchases.
  In addition, such funds will be available to be loaned to the Bank, if
  necessary, in the event and to the extent loan growth exceeds deposit growth
  or for other corporate purposes.  A portion of the net proceeds may be used to
  acquire shares of common stock pursuant to a restricted stock plan, if
  implemented or to purchase shares to be held by a grantor trust for issuance
  to option holders upon the exercise of options in the event a stock option
  plan is implemented.  See "Management of the Bank -- Proposed Future Stock
  Benefit Plans -- Stock Option Plan" and "-- Management Recognition Plan."  We
  do not have any specific plans regarding possible stock repurchases during the
  first year following the Stock Conversion.

       The proceeds contributed to the Converted Bank will ultimately become
  part of the Converted Bank's general corporate funds to be used for its
  business activities, including making loans and investments.  Initially, it is
  expected that the proceeds will be invested in short-term and intermediate-
  term securities including cash and cash equivalents and U.S. Government and
  agency obligations.  The Converted Bank ultimately plans to use such proceeds
  primarily to originate loans in the ordinary course of business.

                                DIVIDEND POLICY

       The payment of cash dividends on the common stock will be subject to the
  requirements of applicable law.  In addition, the determination of whether to
  pay dividends is made by the Board of Directors.  The Board will take into
  account, among other things, our net income, capital and financial condition,
  industry trends and general economic conditions.  We intend to establish a
  quarterly cash dividend following the Conversion at an initial quarterly rate
  of approximately $.10 per share (or an annual rate of $.40 per share, or
  approximately 2.0% based on the $20.00 per share Purchase Price), commencing
  during the first full calendar quarter subsequent to the Stock Conversion.  In
  addition, from time to time in an effort to manage capital to a reasonable
  level, the Board may determine if it is prudent to pay periodic special cash
  dividends.  Periodic special cash dividends, if paid, may be paid in addition
  to, or in lieu of, regular cash dividends.  There can be no assurance that
  regular cash dividends or periodic special cash dividends will be paid or
  that, if paid, will continue to be paid.

       Dividend payments by the Company are subject to regulatory restrictions
  under Federal Reserve Board policy as well as to limitations under applicable
  provisions of Virginia corporate law.  The Federal Reserve Board has issued a
  policy statement on the payment of cash dividends by bank holding companies,
  which expresses the Federal Reserve Board's view that a bank holding company
  should pay cash dividends only to the extent that the company's net income for
  the past year is sufficient to cover both the cash dividends and a rate of
  earning retention that is consistent with the company's capital needs, asset
  quality and overall financial condition.  The Federal Reserve Board also
  indicated that it would be inappropriate for a company experiencing serious
  financial problems to borrow funds to pay dividends.  Furthermore, the Federal
  Reserve Board may prohibit a bank holding company from paying any dividends if
  the holding company's bank subsidiary is classified as "undercapitalized".
  See "Regulation -- Regulation of the Company Following 

                                       7
<PAGE>
 
  the Bank Conversion --Dividends." Under Virginia law, dividends may not be
  paid only if payment of a dividend would cause the Company to be unable to pay
  its debts as they become due or would result in total assets being less than
  the sum of total liabilities plus any amount required to be paid to holders of
  preferred stock in the event of liquidation of the Company.

       We have agreed with the FDIC not to make a tax-free cash distribution to
  stockholders for a period of one year following consummation of the Stock
  Conversion.  In addition, we have agreed with the FDIC not to file a private
  letter ruling request with the Internal Revenue Service regarding the tax-free
  nature of a possible one-time cash distribution to Company stockholders for a
  period of one year following consummation of the Stock Conversion.

       Because the Company initially will have no significant source of income
  other than dividends from the Converted Bank and earnings from investment of
  the net proceeds of the Offering retained by the Company, the payment of
  dividends by the Company will depend in part upon the receipt of dividends
  from the Converted Bank, which is subject to various tax and regulatory
  restrictions.  See "Regulation -- Depository Institution Regulation --
  Dividend Restrictions."


                          MARKET FOR THE COMMON STOCK

       The Company has never issued capital stock to the public.  Consequently,
  there is no established market for the common stock.  We have received
  conditional approval to have the common stock listed on the Nasdaq National
  Market under the symbol "_____".  For initial inclusion for listing on Nasdaq,
  the Company must have three active and registered market makers.  Trident
  Securities has advised us that it will act as a market maker for the common
  stock, and we expect that additional market makers will be identified.  The
  development of a liquid public market depends on the existence of willing
  buyers and sellers, the presence of which is not within our control, and the
  number of active buyers and sellers of the common stock at any particular time
  may be limited.  Under such circumstances, you could have difficulty disposing
  of your shares and should view the common stock as a long-term investment.  We
  cannot assure you that an active and liquid trading market for the common
  stock will develop, or, if developed, it will continue, or that you will be
  able to sell your shares at or above the $20.00 Purchase Price.

                                       8
<PAGE>
 
                                 CAPITALIZATION

       The following table sets forth our historical capitalization, including
  deposits, at September 30, 1998 and our pro forma consolidated capitalization
  giving effect to the sale of the common stock in the Offering based upon the
  assumptions set forth under "Pro Forma Data" and below.  Depending on market
  and financial conditions, the total number of shares to be issued in the Stock
  Conversion may be significantly increased or decreased above or below the
  midpoint of the Estimated Valuation Range.  We may consummate the Stock
  Conversion without a resolicitation of subscribers and other purchasers if the
  aggregate purchase price of the common stock sold in the Stock Conversion is
  above the minimum of the Estimated Valuation Range or less than 15% above the
  maximum of the Estimated Valuation Range.  A CHANGE IN THE NUMBER OF SHARES TO
  BE ISSUED IN THE STOCK CONVERSION MAY MATERIALLY AFFECT THE COMPANY'S PRO
  FORMA CAPITALIZATION.  SEE "PRO FORMA DATA" AND "THE CONVERSION -- STOCK
  PRICING AND NUMBER OF SHARES TO BE ISSUED."

<TABLE>
<CAPTION>
 
                                                                  Pro Forma Consolidated Capitalization of                       
                                    Capitalization           the Company at September 30, 1998 Based on the Sale of              
                                        of the    ---------------------------------------------------------------------------------
                                       Bank at     1,275,000 Shares   1,500,000 Shares     1,725,000 Shares      1,983,750 Shares
                                    September 30,      at $20.00          at $20.00           at $20.00             at $20.00
                                         1998          Per Share          Per Share           Per Share             Per Share
                                    -------------- -----------------  -----------------  --------------------  --------------------
                                                                            (In thousands)
<S>                                 <C>            <C>                <C>                <C>                   <C>
  Deposits (1).....................      $235,694          $235,694           $235,694         $235,694              $235,694
  FHLB advances....................        20,000            20,000             20,000           20,000                20,000
                                         --------          --------           --------         --------              --------
      Total deposits and                                                                       
       borrowed funds..............      $255,694          $255,694           $255,694         $255,694              $255,694
                                         ========          ========           ========         ========              ========
                                                                                               
  Capital stock                                                                                
    Preferred stock, $.01 par                                                                  
     value per share:                                                                          
      authorized - 1,000,000                                                                   
       shares;                                                                                 
      assumed outstanding - none...      $     --          $     --           $     --         $     --              $     --
    Common stock, $.01 par value                                                               
     per share:                                                                                
      authorized - 7,000,000                                                                   
       shares;                                                                                 
      shares to be outstanding -                                                               
       as shown, plus 150,000                                                                  
       shares                                                                                  
      issued to Foundation.........            --                14                 17               19                    21
    Paid-in capital (2)............            --            27,508             31,943           36,379                41,481
    Less:  Expense of                                                                          
     contribution to Foundation                                                                
     (3)...........................                          (3,000)            (3,000)          (3,000)               (3,000)
    Plus:  Tax benefit of                                                                      
     contribution to Foundation                                                                
     (4)...........................                           1,020              1,020            1,020                 1,020
    Less:  Common stock acquired                                                               
     by ESOP (5)...................            --            (2,280)            (2,640)          (3,000)               (3,414)
           Common stock                                                                        
            acquired by MRP (6)                --            (1,140)            (1,320)          (1,500)               (1,707)
                                                                                               
    Retained income (7)............        25,873            25,873             25,873           25,873                25,873
    Net unrealized gains on                                                                    
     investment securities                                                                     
     available                                                                                 
        for sale...................            93                93                 93               93                    93
                                         --------          --------           --------         --------              --------
      Total stockholders' equity...      $ 25,966          $ 48,088           $ 51,986         $ 55,884              $ 60,367
                                         ========          ========           ========         ========              ========
</TABLE>

                                                   (footnotes on following page)

                                       9
<PAGE>
 
(footnotes for table on previous page)

--------------------
(1)  Withdrawals from savings accounts for the purchase of stock have not been
     reflected in these adjustments. Any withdrawals will reduce pro forma
     capitalization by the amount of such withdrawals.

(2)  Based upon the estimated net proceeds from the sale of capital stock less
     the par value of shares sold. Estimated Offering expenses are $978,000,
     $1,040,000, $1,102,000 and $1,173,000 at the minimum, midpoint, maximum and
     maximum, as adjusted of the Estimated Valuation Range. Does not reflect
     additional shares of common stock that possibly could be purchased by
     participants in the stock option plan, if implemented, under which
     directors, executive officers and other employees could be granted options
     to purchase an aggregate of up to 10% of the shares of common stock issued
     in the Stock Conversion, including shares contributed to the Foundation, at
     exercise prices equal to the market price of the common stock on the date
     of grant. Implementation of the stock option plan within one year after the
     Stock Conversion will require regulatory and stockholder approval. See
     "Management of the Bank -- Proposed Future Stock Benefit Plans -- Stock
     Option Plan" and "Risk Factors -- Possible Dilutive Effect of Employee
     Stock Benefit Plans."

(3)  Reflects the issuance of 150,000 shares of common stock to the Foundation
     at an assumed value of $20.00 per share.

(4)  Reflects the tax effect of the contribution of common stock based upon a
     34% marginal federal tax rate. The realization of the deferred tax benefit
     is limited annually to 10% of our annual taxable income, subject to our
     ability to carry forward any unused portion of the deduction for five years
     following the year in which the contribution is made.

(5)  Assumes 8% of the shares of common stock to be sold in the Offering,
     including shares contributed to the Foundation, are purchased by the ESOP
     and that the funds used to purchase such shares are borrowed from the
     Company. See "Pro Forma Data" for additional details.

(6)  Assumes that a number of shares equal to 4% of the number of shares sold in
     the Offering, including shares contributed to the Foundation, will be
     acquired in the open market at the Purchase Price per share ($20.00) for
     the restricted stock plan following implementation of such plan. If the
     restricted stock plan were funded by authorized but unissued shares, your
     interests would be diluted by approximately 4%. Implementation of such a
     plan within one year of the Stock Conversion would require regulatory and
     shareholder approval at a meeting of our stockholders to be held no earlier
     than six months after the Stock Conversion. See "Management of the Bank --
     Proposed Future Stock Benefit Plans -- Management Recognition Plan."

(7)  The retained income of the Bank is substantially restricted. All capital
     distributions by the Bank are subject to regulatory restrictions tied to
     its regulatory capital level. In addition, after the Stock Conversion, the
     Bank will be prohibited from paying any dividend that would reduce its
     regulatory capital below the amount in the liquidation account to be
     provided for the benefit of the Bank's Eligible Account Holders and
     Supplemental Eligible Account Holders at the time of the Stock Conversion
     and adjusted downward thereafter. See "Regulation -- Depository Institution
     Regulation -- Dividend Restrictions" and "The Conversion -- Effect of
     Conversion to Stock Form on Depositors and Borrowers of the Bank --
     Liquidation Account."

                                       10
<PAGE>
 
            HISTORICAL AND PRO FORMA REGULATORY CAPITAL COMPLIANCE

     We are subject to North Carolina law, which requires that net worth,
computed in accordance with the requirements of the Administrator, equal or
exceed 5% of total assets. In addition, we are subject to the capital
requirements of the FDIC. The FDIC requires that institutions which receive the
highest rating during their examination process and are not experiencing or
anticipating significant growth must maintain a leverage ratio of Tier 1 capital
to "total assets" (as defined in FDIC regulations) of at least 3%. All other
institutions are required to maintain a ratio of 1% or 2% above the 3% minimum
with an absolute minimum leverage ratio of not less than 4%. The FDIC also
imposes requirements that (i) the ratio of Tier 1 capital to risk-weighted
assets equal at least 4%, and (ii) the ratio of total capital to risk-weighted
assets equal at least 8%.

     After the Bank Conversion, the Converted Bank will continue to be subject
to the FDIC's capital requirements and the Company will be required to satisfy
Federal Reserve Board capital requirements, which are similar but not identical
to the FDIC's capital requirements. The following table sets forth our
historical capital position relative to the various minimum Administrator and
FDIC capital regulatory requirements to which we are currently subject. The next
table sets forth our historical capital position and thereafter presents pro
forma data relative to such Federal Reserve Board capital requirements to which
the Converted Bank will be subject. For additional information regarding our
financial condition and the assumptions underlying the pro forma capital
calculations set forth below, see "Use of Proceeds," "Capitalization" and "Pro
Forma Data" and the consolidated financial statements and related notes
appearing elsewhere in this Prospectus.

<TABLE>
<CAPTION>
                                                            Historical at
                                                         September 30, 1998
                                                         --------------------
                                                                   Percent of
                                                         Amount    Assets(1)
                                                         ------    ----------
                                                        (Dollars in thousands)
<S>                                                      <C>       <C>
Tier 1/leverage capital........................          $25,873    9.13%
Tier 1/leverage capital requirement                       11,334    4.00
                                                         -------   -----
 Excess                                                  $14,539    5.13%
                                                         =======   =====
                                                                   
Tier 1 risk-based capital......................          $25,873   14.53%
Tier 1 risk-based capital requirement                      7,124    4.00 
                                                         -------   -----
 Excess                                                  $18,749   10.53%
                                                         =======   =====
                                                                   
Total risk-based capital.......................          $28,112   15.78%
Total risk-based capital requirement                      14,249    8.00
                                                         -------   -----
 Excess                                                  $13,863    7.78%
                                                         =======   ===== 
                                                                   
North Carolina regulatory capital..............          $28,112    9.75%
North Carolina regulatory capital requirement             14,411    5.00
                                                         -------   -----
 Excess                                                  $13,701    4.75%
                                                         =======   ===== 
</TABLE>

--------------------
(1)  The ratio of leverage capital is based on quarterly average assets for the
     year ended September 30, 1998. Tier 1 risk-based capital and total risk-
     based capital is based on risk-weighted assets at September 30, 1998. The
     North Carolina regulatory capital requirement is based on total assets at
     September 30, 1998.

                                       11
<PAGE>
 
<TABLE>
<CAPTION>
                                                                                                                               
                     Bank's Historical   Pro Forma Capital of the Converted  Bank as of September 30, 1998 Based on the Sale of (1):
                   Capital at September  -------------------------------------------------------------------------------------------
                    30, 1998 Assuming     1,275,000 Shares   1,500,000 Shares     1,725,000 Shares     1,983,750 Shares            
                   Federal Reserve Board     at $20.00          at $20.00            at $20.00            at $20.00               
                   Capital Requirements      Per Share          Per Share            Per Share            Per Share               
                   --------------------- ------------------- ----------------- ------------------- -------------------            
                            Percent of            Percent of         Percent of         Percent of         Percent of  
                   Amount   Assets (2)   Amount   Assets (2) Amount  Assets (2) Amount  Assets (2) Amount  Assets (2)             
                   ------   ----------   ------   ---------- ------  ---------  ------  ---------- ------  ----------             
                                                                 (Dollars in  thousands) 
<S>                <C>      <C>          <C>      <C>        <C>     <C>        <C>     <C>        <C>     <C>        
Capital under 
 generally 
  accepted 
   accounting                                                                                                              
    principles...  $25,966      9.0%     $37,087    12.4%   $39,126    13.0%    $41,165      13.6% $43,510      14.2%  
                   =======      ====     =======    ====    =======    ====     =======      ====  =======      ====   
Tier 1 (core) to 
 total assets....  $25,873      9.0%     $36,994    12.4%   $39,033    13.0%    $41,072      13.5% $43,417      14.2% 
Tier 1 (core)                         
 capital                              
  requirement                         
  (3)............   11,555      4.0       11,970     4.0     12,052     4.0      12,133       4.0   12,227       4.0  
                   -------     ----      -------    ----    -------    ----     -------      ----  -------      ----  
   Excess........  $14,318      5.0%     $25,024     8.4%   $26,981     9.0%    $28,939       9.5% $31,190      10.2% 
                   =======     ====      =======    ====    =======    ====     =======      ====  =======      ====  
                                                                                                                                 
Tier 1 (core)                         
 capital to                                                                                                         
  risk-weighted                       
   assets........  $25,873     14.5%     $36,994    20.1%   $39,033    21.1%    $41,072      22.1% $43,417      23.2% 
Tier 1 (core)                         
 capital                                                                                                            
  requirement....    7,124      4.0        7,347     4.0      7,388     4.0       7,428       4.0    7,475       4.0  
                   -------     ----      -------    ----    -------    ----     -------      ----  -------      ----  
   Excess........  $18,749     10.5%     $29,647    16.1    $31,645    17.1%    $33,644      18.1% $35,942      19.2% 
                   =======     ====      =======    ====    =======    ====     =======      ====  =======      ====  
                                                                                                                                 
Total capital to                                                                                                                 
 risk-weighted                        
  assets.........  $28,112     15.8%     $39,233    21.4%   $41,272    22.3%    $43,311      23.3% $45,656      24.4% 
Total capital                         
 requirement.....   14,249      8.0       14,694     8.0     14,775     8.0      14,857       8.0   14,951       8.0  
                   -------     ----      -------    ----    -------    ----     -------      ----  -------      ----  
   Excess........  $13,863      7.8%     $24,539    13.4%   $26,497    14.3%    $28,454      15.3% $30,705      16.4% 
                   =======     ====      =======    ====    =======    ====     =======      ====  =======      ====  
</TABLE> 
     --------------------
     (1)  Assumes the Company will purchase all of the capital stock of the
          Converted Bank to be issued in the Stock Conversion in exchange for
          50% of the net proceeds. Assumes net proceeds distributed to the
          Company or the Converted Bank initially are invested in assets with a
          50% risk-weighting. The numbers of shares sold do not include the
          150,000 shares to be contributed to the Foundation.

     (2)  Based on our total assets for capital as determined under generally
          accepted accounting principles and Tier 1 capital purposes, and risk-
          weighted assets for the purpose of the risk-based capital
          requirements.

     (3)  Assumes a core capital requirement of 4% adjusted total assets, though
          such level may be increased by the Federal Reserve Board to as high as
          5%. See "Regulation -- Depository Institution Regulation -- Capital
          Requirements."

                                       12
<PAGE>
 
                                 PRO FORMA DATA

     The actual net proceeds from the sale of the common stock cannot be
determined until the Stock Conversion is completed.  However, investable net
proceeds are currently estimated to be between $21.1 million and $33.4 million
at the minimum and maximum as adjusted, of the Estimated Valuation Range,
based upon the following assumptions (i) 100% of the shares of common stock
will be sold in the Subscription and Community Offerings and the Syndicated
Community Offering as follows, with the exception of shares being contributed
to the Foundation, for which no proceeds will be received and no commissions
will be paid:  (a) 132,000 shares will be sold to the ESOP and 437,500 shares
will be sold to directors and officers of the Bank and their associates and to
employees, for which commissions will not be paid; and (b) the remaining
shares will be sold to others in the Subscription and Community Offerings; and
(ii) other Conversion expenses, not including sales commissions, will be
approximately $761,000.

     The following table sets forth our historical net earnings and
stockholders' equity prior to the Stock Conversion and our pro forma
consolidated net income and stockholders' equity following the Stock
Conversion.  Pro forma consolidated net income and stockholders' equity have
been calculated as if the common stock to be issued in the Stock Conversion
had been sold at October 1, 1997, and the estimated net proceeds had been
invested at 4.50%, which was approximately equal to the one-year U.S. Treasury
bill rate at September 30, 1998.  We used the one-year U.S. Treasury bill
rate, rather than an arithmetic average of the average yield on interest-
earning assets and average rate paid on deposits, to estimate income on net
proceeds because we believe that this is a more accurate estimate of the rate
that would be obtained on an investment of net proceeds from the Offering.  In
calculating pro forma income, an effective state and federal income tax rate
of 36.0% has been assumed, resulting in an after tax yield of 2.88%.
Withdrawals from deposit accounts for the purchase of shares are not reflected
in the pro forma adjustments.  As discussed under "Use of Proceeds," the
Company expects to retain a portion of the net Offering proceeds, part of
which will be loaned to the ESOP to fund its purchase of 8% of the shares
issued, including shares contributed to the Foundation, in the Stock
Conversion.  No effect has been given in the pro forma stockholders' equity
calculation for the assumed earnings on the net proceeds. Historical and pro
forma per share amounts have been calculated by dividing historical and pro
forma amounts by the indicated number of shares.

     THE STOCKHOLDERS' EQUITY AND RELATED DATA PRESENTED HEREIN ARE NOT INTENDED
TO REPRESENT THE FAIR MARKET VALUE OF THE COMMON STOCK, THE CURRENT VALUE OF
ASSETS OR LIABILITIES, OR THE AMOUNTS, IF ANY, THAT WOULD BE AVAILABLE FOR
DISTRIBUTION TO STOCKHOLDERS IN THE EVENT OF LIQUIDATION. FOR ADDITIONAL
INFORMATION REGARDING THE LIQUIDATION ACCOUNT, SEE "THE CONVERSION -- EFFECT OF
CONVERSION TO STOCK FORM ON DEPOSITORS AND BORROWERS OF THE BANK --LIQUIDATION
ACCOUNT." THE PRO FORMA INCOME AND RELATED DATA DERIVED FROM THE ASSUMPTIONS SET
FORTH ABOVE SHOULD NOT BE CONSIDERED INDICATIVE OF OUR ACTUAL RESULTS OF
OPERATIONS FOR ANY CURRENT OR FUTURE PERIOD. SUCH PRO FORMA DATA MAY BE
MATERIALLY AFFECTED BY A CHANGE IN THE NUMBER OF SHARES TO BE ISSUED IN THE
STOCK CONVERSION AND OTHER FACTORS. SEE "THE CONVERSION -- STOCK PRICING AND
NUMBER OF SHARES TO BE ISSUED." THE FOLLOWING TABLE DOES NOT REFLECT THE AFTER-
TAX EXPENSE OF $2.0 MILLION WE WILL INCUR DURING THE YEAR ENDING SEPTEMBER 30,
1999 AS A RESULT OF OUR CONTRIBUTION OF 150,000 SHARES OF COMMON STOCK TO THE
FOUNDATION.

                                       13
<PAGE>
 
<TABLE>
<CAPTION>
                                                                 At or for the Year Ended September 30, 1998
                                                      --------------------------------------------------------------
                                                       1,275,000          1,500,000        1,725,000       1,983,750
                                                         Shares             Shares           Shares          Shares
                                                       at $20.00          at $20.00        at $20.00       at $20.00
                                                       Per Share          Per Share        Per Share       Per Share
                                                       ---------          ---------        ---------       ---------
                                                               (Dollars in thousands, except per share amounts)
<S>                                                   <C>                <C>              <C>             <C> 
Gross offering proceeds...........................    $   25,500         $   30,000       $   34,500      $   39,675
Plus: Shares issued to Foundation.................         3,000              3,000            3,000           3,000
                                                      ----------         ----------       ----------      ----------
  Pro Forma market capitalization.................    $   28,500         $   33,000       $   37,500      $   42,675
                                                      ==========         ==========       ==========      ==========
                                           
Gross offering proceeds...........................    $   25,500         $   30,000       $   34,500      $   39,675
Less estimated offering expenses..................          (978)            (1,040)          (1,102)         (1,173)
                                                      ----------         ----------       ----------      ----------
  Estimated net offering proceeds.................    $   24,522         $   28,960       $   33,398      $   38,502
Less:  ESOP funded by the Company.................        (2,280)            (2,640)          (3,000)         (3,414)
       MRP........................................        (1,140)            (1,320)          (1,500)         (1,707)
                                                      ----------         ----------       ----------      ----------
  Estimated investable net proceeds...............    $   21,102         $   25,000       $   28,898      $   33,381
                                                      ==========         ==========       ==========      ==========
                                           
Net income:                                
  Historical net income...........................    $    2,521         $    2,521       $    2,521      $    2,521
  Pro forma income on investable net proceeds.....           608                720              832             961
  Pro forma ESOP adjustment (1)...................          (146)              (169)            (192)           (218)
  Pro forma MRP adjustment (2)....................          (146)              (169)            (192)           (218)
                                                      ----------         ----------       ----------      ----------
      Total.......................................    $    2,837         $    2,903       $    2,969      $    3,046
                                                      ==========         ==========       ==========      ==========
   
 Net income per share:
   Historical net income..........................    $     1.91         $     1.65       $     1.45      $     1.27
   Pro forma income on investable net proceeds....          0.46               0.47             0.48            0.49
   Pro forma ESOP adjustment (1)..................         (0.11)             (0.11)           (0.11)          (0.11)
   Pro forma MRP adjustment (2)...................         (0.11)             (0.11)           (0.11)          (0.11)
                                                      ----------         ----------       ----------      ----------
     Total........................................    $     2.15         $     1.90       $     1.71      $     1.54
                                                      ==========         ==========       ==========      ==========
 
Weighted average number of shares outstanding
 for earnings per share calculations (1)..........     1,322,400          1,531,200        1,740,000       1,980,120
 
Stockholders' equity: (3)
  Historical......................................    $   25,966         $   25,966       $   25,966      $   25,966
  Estimated net proceeds (2)(4)...................        24,522             28,960           33,398          38,502
  Plus: Shares issued to Foundation...............         3,000              3,000            3,000           3,000
  Less: Contribution to Foundation................        (3,000)            (3,000)          (3,000)         (3,000)
  Plus:  Tax benefit of the contribution         
         to the  Foundation.......................         1,020              1,020            1,020           1,020
  Less:   Common stock acquired by ESOP (1).......        (2,280)            (2,640)          (3,000)         (3,414)
          Common stock acquired by MRP (2)........        (1,140)            (1,320)          (1,500)         (1,707)
                                                      ----------         ----------       ----------      ----------
     Total........................................    $   48,088         $   51,986       $   55,884      $   60,367
                                                      ==========         ==========       ==========      ==========
                                                 
Stockholders' equity per share: (3)              
  Historical......................................    $    18.22         $    15.74       $    13.85      $    12.17
  Estimated net proceeds (2)(4)...................         17.21              17.55            17.81           18.04
  Plus: Shares issued to Foundation...............          2.11               1.82             1.60            1.41
  Less: Contribution to Foundation................         (2.11)             (1.82)           (1.60)          (1.41)
  Plus: Tax benefit of the contribution          
        to the  Foundation........................          0.72               0.62            0. 54            0.48
  Less:   Common stock acquired by ESOP (1).......         (1.60)             (1.60)           (1.60)          (1.60)
          Common stock acquired by MRP (2)........         (0.80)             (0.80)           (0.80)          (0.80)
                                                      ----------         ----------       ----------      ----------
     Total........................................    $    33.75         $    31.51       $    29.80      $    28.29
                                                      ==========         ==========       ==========      ==========
 
Number of shares outstanding for
 stockholders' equity per share calculations......     1,425,000          1,650,000        1,875,000       2,133,750
 
Offering price as a percentage of pro forma
 stockholders' equity per share...................          59.3%              63.5%            67.1%           70.7%
                                                      ==========         ==========       ==========      ==========
 
Ratio of offering price to pro forma
 net income per share.............................           9.3x              10.5x            11.7x           13.0x
                                                      ==========         ==========       ==========      ==========

                                                                                          (Footnotes on succeeding page)
</TABLE> 

                                      14
<PAGE>
 
-------------------------
(1)       Assumes the ESOP purchases 8% of the shares to be sold in the Stock
          Conversion, including shares contributed to the Foundation, and that
          the Company lends the ESOP the funds to do so. The approximate amount
          expected to be borrowed by the ESOP is not reflected as a liability
          but is reflected as a reduction of capital. Although repayment of such
          debt will be secured solely by the shares purchased by the ESOP, the
          Converted Bank expects to make discretionary contributions to the ESOP
          in an amount at least equal to the principal and interest payments on
          the ESOP debt. Pro forma net income has been adjusted to give effect
          to such contributions, based upon a fully amortizing debt with a ten-
          year term. Because the Company will be providing the ESOP loan, only
          principal payments on the ESOP loan are reflected as employee
          compensation and benefits expense. The Purchase Price of $20.00 was
          utilized to calculate the ESOP expense. The Bank intends to record
          compensation expense related to the ESOP in accordance with AICPA SOP
          No. 93-6. As a result, to the extent the value of the common stock
          appreciates over time, compensation expense related to the ESOP will
          increase. SOP 93-6 and SFAS No. 128 require the earnings per share
          computations for companies with leveraged ESOPs to include as
          outstanding only shares that have been committed to be released to
          participants. The table assumes that 10% of the ESOP shares purchased
          in the Stock Conversion were committed to be released. See "Management
          of the Bank -- Executive Compensation -- Employee Stock Ownership
          Plan.
(2)       Assumes a number of shares of common stock equal to 4% of the common
          stock to be sold in the Stock Conversion, including shares contributed
          to the Foundation, will be purchased by a restricted stock plan (the
          "MRP") in the open market following the Stock Conversion. The dollar
          amount of the common stock to be purchased by the MRP is based on the
          Purchase Price in the Stock Conversion and represents unearned
          compensation and is reflected as a reduction of capital. Such amount
          does not reflect possible increases or decreases in the value of such
          stock relative to the Purchase Price of $20.00 in the Stock
          Conversion. As the Converted Bank accrues compensation expense to
          reflect the vesting of such shares pursuant to the MRP, the charge
          against capital will be reduced accordingly. Implementation of the MRP
          within one year of the Stock Conversion would require stockholder
          approval at a meeting of our stockholders. If the shares to be
          purchased by the MRP were newly issued shares purchased from the
          Company by the MRP at the Purchase Price rather than shares purchased
          in the open market, at the minimum, midpoint, maximum and 15% above
          the maximum of the Estimated Valuation Range, pro forma stockholders'
          equity per share would have been $33.22, $31.06, $29.43 and $27.97,
          respectively, and pro forma net income per share would have been
          $2.08, $1.84, $1.66 and $1.50, respectively. If the MRP acquires
          authorized but unissued shares from the Company, your ownership
          interests in the Company would be diluted by approximately 4%. See
          "Management of the Bank -- Proposed Future Stock Benefit Plans --
          Management Recognition Plan" and "Risk Factors --Dilutive Effect of
          MRP and Stock Options."
(3)       Consolidated stockholders' equity represents the excess of the
          carrying value of our assets over our liabilities. The amounts shown
          do not reflect the federal income tax consequences of the potential
          restoration to income of the bad debt reserves for income tax
          purposes, which would be required in the event of liquidation or in
          certain other remote circumstances. The amounts shown also do not
          reflect the amounts required to be distributed in the event of
          liquidation to eligible depositors from the liquidation account which
          will be established upon the consummation of the Stock Conversion. Pro
          forma stockholders' equity information is not intended to represent
          the fair market value of the common stock, the current value of the
          Bank's assets or liabilities or the amounts, if any, that would be
          available for distribution to stockholders in the event of
          liquidation. Such pro forma data may be materially affected by a
          change in the number of shares to be sold in the Stock Conversion and
          by other factors.
(4)       No effect has been given to shares that may be issued upon the
          exercise of options that may be granted under a stock option plan. 

                                       15
<PAGE>
 
     COMPARISON OF VALUATION AND PRO FORMA INFORMATION WITH NO FOUNDATION

       Had we not established the Foundation as part of the Stock Conversion,
  Ferguson has estimated that our pro forma market capitalization would have
  been approximately $35.0 million, at the midpoint, which is approximately $2.0
  million greater than our pro forma market capitalization with the Foundation.
  This would result in approximately a $5.0 million increase in the amount of
  common stock that would be offered for sale in the Offering.  Further, at the
  midpoint of the Estimated Valuation Range, pro forma stockholders' equity per
  share and pro forma consolidated net income per share would be $31.51 and
  $1.90, respectively, with the Foundation, as compared to $31.84 and $1.86,
  respectively, without the Foundation.  At the midpoint of the Estimated
  Valuation Range, the pro forma price to book ratio and the pro forma price to
  earnings ratio are 63.5% and 10.5x, respectively, with the Foundation, as
  compared to 62.9% and 10.8x, respectively, without the Foundation.  The
  following table does not reflect the after-tax expense of $2.0 million we will
  incur during the year ending September 30, 1999 as a result of our
  contribution of 150,000 shares of common stock to the Foundation.

       For comparative purposes only, set forth below are certain pricing ratios
  and financial data and ratios, at the minimum, midpoint, maximum and maximum,
  as adjusted, of the Estimated Valuation Range, assuming the Stock Conversion
  was completed at September 30, 1998.

<TABLE>
<CAPTION>
                               1,275,000 Shares at         1,500,000 Shares         1,725,000 Shares at       1,983,750 Shares at 
                                 $20.00 Per Share          $20.00 Per Share          $20.00 Per Share          $20.00 Per Share  
                             -----------------------   -----------------------   -----------------------   ----------------------- 
                                With          No          With          No          With          No          With          No
                             Foundation   Foundation   Foundation   Foundation   Foundation   Foundation   Foundation   Foundation
                             ----------   ----------   ----------   ----------   -----------  ----------   -----------  ----------
                                                         (Dollars in thousands, except per share data)
<S>                          <C>          <C>          <C>          <C>          <C>          <C>          <C>          <C>
 
  Estimated gross offering
   amount..................    $ 25,500     $ 29,750     $ 30,000     $ 35,000     $ 34,500     $ 40,250     $ 39,675     $ 46,288
  Pro forma market
   capitalization..........      28,500       29,750       33,000       35,000       37,500       40,250       42,675       46,288
  Total assets.............     309,325      313,363      313,223      317,911      317,121      322,458      321,604      327,689
  Total liabilities........     262,258      262,258      262,258      262,258      262,258      262,258      262,258      262,258
  Pro forma stockholders'
   equity..................      48,088       51,106       51,986       55,654       55,884       60,201       60,367       65,432
  Pro forma consolidated
   net earnings............       2,837        2,940        2,903        3,018        2,969        3,095        3,046        3,184
  Pro forma stockholders'
   equity per share........       33.75        34.36        31.51        31.80        29.80        29.91        28.29        28.27
  Pro forma consolidated
   net income
    per share..............        2.15         2.13         1.90         1.86         1.71         1.66         1.54         1.48
 
  Pro forma pricing ratios:
     Offering price as a
      percentage of pro
       forma stockholders'
        equity per share...        59.3%        58.2%        63.5%        62.9%        67.1%        66.9%        70.7%        70.7%
     Offering price to pro
      forma net earnings
          per share........         9.3x         9.4x        10.5x        10.8x        11.7x        12.0x        13.0x        13.5x
     Offering price to
      assets per share.....         9.2%         9.5%        10.5%        11.0%        11.8%        12.5%        13.3%        14.1%
 
  Pro forma financial
   ratios:
      Return on assets.....        0.96%        0.99%        0.97%        1.00%        0.98%        1.01%        0.99%        1.02%
      Return on
       stockholders' equity        6.07%        5.91%        5.73%        5.56%        5.44%        5.26%        5.16%        4.97%
      Stockholders' equity
       to assets...........        15.5%        16.3%        16.6%        17.5%        17.6%        18.7%        18.8%        20.0%
</TABLE>

                                       16
<PAGE>
 
                                 THE CONVERSION

       OUR BOARD OF DIRECTORS AND THE ADMINISTRATOR HAVE APPROVED THE PLAN,
  SUBJECT TO THE PLAN'S APPROVAL BY OUR MEMBERS ENTITLED TO VOTE ON THE MATTER
  AND SUBJECT TO THE SATISFACTION OF CERTAIN OTHER CONDITIONS.  SUCH APPROVAL BY
  THE ADMINISTRATOR, HOWEVER, DOES NOT CONSTITUTE A RECOMMENDATION OR
  ENDORSEMENT OF THE PLAN.

  GENERAL

       On August 11, 1998, our Board of Directors unanimously adopted, subject
  to approval by the Administrator and our members, and to the nonobjection by
  the FDIC, the Plan, pursuant to which we would implement the Conversion.  The
  Administrator has approved the Plan subject to, among other things, approval
  of the Plan by our members.  In addition, the FDIC has issued its conditional
  non-objection to the Plan and the Stock Conversion.  A Special Meeting of our
  members has been called for the purpose of approving the Plan, which meeting
  is to be held on ___________, 1999.

       The Stock Conversion will be accomplished through the amendment of the
  Bank's existing North Carolina mutual Articles of Incorporation and Bylaws to
  read in the form of North Carolina stock Articles of Incorporation and Bylaws
  to authorize the issuance of capital stock by the Converted Bank, the issuance
  of all the Converted Bank's capital stock to be outstanding upon consummation
  of the Stock Conversion to the Company and the offer and sale of the common
  stock of the Company.  Upon issuance of the Converted Bank's shares of capital
  stock to the Company, the Converted Bank will be a wholly owned subsidiary of
  the Company.  Immediately following consummation of the Stock Conversion, the
  Board of Directors of the Bank intends to complete the Bank Conversion.  Upon
  completion of the Bank Conversion, the Converted Bank will remain a wholly
  owned subsidiary of the Company.

       The Stock Conversion will be effected only upon completion of the sale of
  all of the shares of common stock to be issued by the Company pursuant to the
  Plan.  The Bank has received approval from the Administrator and the
  Commission, subject to certain conditions, of the conversion of the Converted
  Bank to a North Carolina commercial bank, and the Company has applied to the
  Federal Reserve Board for approval of the Company's continued ownership of
  100% of the stock of the Converted Bank following the Bank Conversion.

       Under the Plan, the Company is offering shares of the common stock first
  to our Eligible Account Holders, second to the ESOP, third to Supplemental
  Eligible Account Holders and fourth to our Other Members who are not Eligible
  Account Holders or Supplemental Eligible Account Holders in the Subscription
  Offering.  Subscription rights received in any of the foregoing categories
  will be subordinated to the subscription rights received by those in a prior
  category.  To the extent shares remain available for purchase after the
  Subscription Offering, the Company may offer any such remaining shares to the
  general public in the Community Offering.  In the Community Offering, we will
  give preference to natural persons and trusts of natural persons who are
  permanent residents of Alamance County, North Carolina. We reserve the right
  to reject any such orders, in whole or in part in the Community Offering.

       As part of the Community Offering, the Plan provides that, if feasible,
  all shares of common stock not purchased in the Subscription and Community
  Offerings, if any, may be offered for sale to the general public in a
  Syndicated Community Offering through a syndicate of selected dealers to be
  formed and managed by Trident Securities.

       The following is a brief summary of material aspects of the Conversion.
  The summary is qualified in its entirety by reference to the provisions of the
  Plan.  A copy of the Plan is available for inspection at any office of the
  Bank and at the office of the Administrator.  The Plan is also filed as an
  exhibit to the Registration Statement of which this Prospectus is a part.
  Copies of the Registration Statement may be obtained from the SEC.  See
  "Additional Information."

                                       17
<PAGE>
 
  BUSINESS PURPOSES

       Our Board of Directors has formed 1st State Bancorp, Inc. to serve upon
  consummation of the Conversion as a holding company for the Converted Bank.
  The portion of the net proceeds from the sale of the common stock in the
  Offering to be distributed to the Converted Bank by the Company will
  substantially increase the Converted Bank's capital position which will in
  turn increase the amount of funds available for lending and investment and
  provide greater resources to support both current operations and future
  expansion by the Converted Bank.  We have no current agreements or
  understandings for such expansion.  The holding company structure will provide
  greater flexibility than the Bank alone would have for diversification of
  business activities and geographic expansion.  We believe that this increased
  capital and operating flexibility will enable the Converted Bank to compete
  more effectively with other types of financial services organizations.  In
  addition, the Conversion will also enhance our future access to the capital
  markets.

       Our Board of Directors determined that operating as a commercial bank
  will allow us to continue to pursue our expanding lines of business.  We
  intend to emphasize commercial real estate loans, commercial loans and
  consumer loans.  See "Risk Factors --  Risks Related to Commercial and
  Consumer Lending" and "Management's Discussion and Analysis of Financial
  Condition and Results of Operations -- General."  We believe this strategy can
  be more effectively developed by operating under regulatory requirements
  applicable to a North Carolina commercial bank rather than a North Carolina-
  chartered savings bank.  See "Regulation -- Depository Institution
  Regulation."

       After completion of the Stock Conversion, the unissued common stock and
  preferred stock authorized by our Articles of Incorporation will permit us,
  subject to market conditions, to raise additional equity capital through
  further sales of securities and to issue securities in connection with
  possible acquisitions.  At the present time, we do not have any plans with
  respect to additional offerings of securities, other than the issuance of
  additional shares under a restricted stock plan or a stock option plan, if
  implemented.  Following completion of the Stock Conversion, we also will be
  able to use stock-related incentive programs to attract and retain executive
  and other personnel.  See "Management of the Bank --Future Proposed Stock
  Benefit Plans."

  EFFECT OF CONVERSION TO STOCK FORM ON DEPOSITORS AND BORROWERS OF THE BANK

       General.  Each depositor in a mutual savings institution such as the Bank
  has both a deposit account and a pro rata ownership interest in the retained
  earnings of that institution based upon the balance in his or her deposit
  account.  However, this ownership interest is tied to the depositor's account
  and has no tangible market value separate from such deposit account.  Any
  other depositor who opens a deposit account obtains a pro rata interest in the
  retained earnings of the institution without any additional payment beyond the
  amount of the deposit.  A depositor who reduces or closes his or her account
  receives a portion or all of the balance in the account but nothing for his or
  her ownership interest, which is lost to the extent that the balance in the
  account is reduced.

       Consequently, depositors normally do not have a way to realize the value
  of their ownership, which has realizable value only in the unlikely event that
  the mutual institution is liquidated.  In such event, the depositors of record
  at that time, as owners, would share pro rata in any residual retained
  earnings after other claims are paid.

       Upon consummation of the Stock Conversion, permanent nonwithdrawable
  capital stock will be created to represent the ownership of the institution.
  The stock is separate and apart from deposit accounts and is not and cannot be
  insured by the FDIC.  Transferable certificates will be issued to evidence
  ownership of the stock, which will enable the stock to be sold or traded, if a
  purchaser is available, with no effect on any account held in the Bank.  Under
  the Plan, all of the capital stock of the Converted Bank will be acquired by
  the Company in exchange for a portion of the net proceeds from the sale of the
  common stock in the Stock Conversion.  The common stock will represent an
  ownership interest in the Company and will be issued upon consummation of the
  Stock Conversion to persons who elect to participate in the Stock Conversion
  by purchasing the shares being offered.

                                       18
<PAGE>
 
       Continuity.  During the Conversion process, our normal business of
  accepting deposits and making loans will continue without interruption.  The
  Converted Bank will continue to be subject to regulation by the Administrator
  and the FDIC, and will be subject to regulation by the Commissioner and the
  FDIC following the Bank Conversion, and FDIC insurance of accounts will
  continue without interruption. After the Conversion, the Converted Bank will
  continue to provide services for depositors and borrowers under current
  policies and by present management and staff.

       The Board of Directors serving the Bank at the time of the Conversion
  will serve as the Board of Directors of the Converted Bank after the
  Conversion.  The Board of Directors of the Company will consist of the
  individuals currently serving on the Board of Directors of the Bank.  All of
  our officers at the time of the Conversion will retain their positions with
  the Converted Bank after the Conversion.

       Voting Rights.  Upon the completion of the Conversion, depositor and
  borrower members as such will have no voting rights in the Converted Bank or
  the Company and, therefore, will not be able to elect directors of the
  Converted Bank or the Company or to control their affairs.  Currently these
  rights are accorded to our depositors.  Subsequent to the Stock Conversion,
  voting rights will be vested exclusively in the stockholders of the Company.
  Each holder of common stock shall be entitled to vote on any matter to be
  considered by the stockholders of the Company, subject to the provisions of
  the Company's Articles of Incorporation.

       Deposit Accounts and Loans. OUR DEPOSIT ACCOUNTS, THE BALANCES OF
  INDIVIDUAL ACCOUNTS AND EXISTING FEDERAL DEPOSIT INSURANCE COVERAGE WILL NOT
  BE AFFECTED BY THE CONVERSION. Furthermore, the Conversion will not affect the
  loan accounts, the balances of these accounts and the obligations of the
  borrowers under their individual contractual arrangements with us.

       Tax Effects.  We have received an opinion from our special counsel,
  Housley Kantarian & Bronstein, P.C., Washington, D.C., as to the material
  federal income tax consequences of the Conversion to the Bank and the
  Converted Bank, and as to the generally applicable material federal income tax
  consequences of the Conversion to our account holders and to persons who
  purchase common stock in the Stock Conversion.  The opinion provides that the
  Conversion will constitute one or more reorganizations for federal income tax
  purposes under Section 368(a)(1)(F) of the Internal Revenue Code.  Among other
  things, the opinion also provides that: (i) no gain or loss will be recognized
  by us in our mutual or stock form by reason of the Stock Conversion; (ii) no
  gain or loss will be recognized by our account holders upon the issuance to
  them of accounts in the Converted Bank in stock form immediately after the
  Stock Conversion, in the same dollar amounts and on the same terms and
  conditions as their accounts with us immediately prior to the Stock
  Conversion; (iii) the tax basis of each account holder's interest in the
  liquidation account will be equal to the value, if any, of that interest; (iv)
  the tax basis of the common stock purchased in the Stock Conversion will be
  equal to the amount paid therefor increased, in the case of common stock
  acquired pursuant to the exercise of subscription rights, by the fair market
  value, if any, of the subscription rights exercised; (v) the holding period
  for the common stock purchased in the Stock Conversion will commence upon the
  exercise of such holder's subscription rights and otherwise on the day
  following the date of such purchase; (vi) gain or loss will be recognized to
  account holders upon the receipt of liquidation rights or the receipt or
  exercise of subscription rights in the Stock Conversion, to the extent such
  liquidation rights and subscription rights are deemed to have value, as
  discussed below; and (vii) as a result of Public Law 104-188, we and our
  successors (including the Converted Bank) will be required to recapture the
  applicable excess reserves into gross income ratably over a six taxable year
  period. The applicable excess reserves are the excess, if any, of (1) the
  balance of our reserves as of the close of our last taxable year beginning
  before January 1, 1996, over (2) the greater of the balance of (a) our pre-
  1988 reserves, or (b) what our reserves would have been at the close of our
  last taxable year beginning before January 1, 1996, had we always used the
  experience method (the six-year average method).

       The opinion of Housley Kantarian & Bronstein, P.C. is based in part upon,
  and subject to the continuing validity in all material respects through the
  date of the Conversion of, our various representations and upon certain
  assumptions and qualifications, including that the Conversion is consummated
  in the manner and according to the terms provided in the Plan.  Such opinion
  is also based upon the Internal Revenue Code, regulations now in effect or
  proposed

                                       19
<PAGE>
 
  thereunder, current administrative rulings and practice and judicial
  authority, all of which are subject to change and such change may be made with
  retroactive effect. Unlike private letter rulings received from the IRS, an
  opinion is not binding upon the IRS and there can be no assurance that the IRS
  will not take a position contrary to the positions reflected in such opinion,
  or that such opinion will be upheld by the courts if challenged by the IRS.

       Housley Kantarian & Bronstein, P.C. has advised us that an interest in a
  liquidation account has been treated by the IRS, in a series of private letter
  rulings which do not constitute formal precedent, as having nominal, if any,
  fair market value and therefore it is likely that the interests in the
  liquidation account established by us as part of the Stock Conversion will
  similarly be treated as having nominal, if any, fair market value.
  Accordingly, it is likely that our  depositors who receive an interest in such
  liquidation account established by us pursuant to the Stock Conversion will
  not recognize any gain or loss upon such receipt.

       Housley Kantarian & Bronstein, P.C. has further advised us that the
  federal income tax treatment of the receipt of subscription rights pursuant to
  the Stock Conversion is uncertain, and recent private letter rulings issued by
  the IRS have been in conflict.  For instance, the IRS adopted the position in
  one private ruling that subscription rights will be deemed to have been
  received to the extent of the minimum pro rata distribution of such rights,
  together with the rights actually exercised in excess of such pro rata
  distribution, and with gain recognized to the extent of the combined fair
  market value of the pro rata distribution of subscription rights plus the
  subscription rights actually exercised.  Persons who do not exercise their
  subscription rights under this analysis would recognize gain upon receipt of
  rights equal to the fair market value of such rights, regardless of exercise,
  and would recognize a corresponding loss upon the expiration of unexercised
  rights that may be available to offset the previously recognized gain.  Under
  another IRS private ruling, subscription rights were deemed to have been
  received only to the extent actually exercised.  This private ruling required
  that gain be recognized only if the holder of such rights exercised such
  rights, and that no loss be recognized if such rights were allowed to expire
  unexercised.  There is no authority that clearly resolves this conflict among
  these private rulings, which may not be relied upon for precedential effect.
  However, based upon express provisions of the Internal Revenue Code and in the
  absence of contrary authoritative guidance, Housley Kantarian & Bronstein,
  P.C. has provided in its opinion that gain will be recognized upon the receipt
  rather than the exercise of subscription rights.  Further, also based upon a
  published IRS ruling and consistent with recognition of gain upon receipt
  rather than exercise of the subscription rights, Housley Kantarian &
  Bronstein, P.C. has provided in its opinion that the subsequent exercise of
  the subscription rights will not give rise to gain or loss.  Regardless of the
  position eventually adopted by the IRS, the tax consequences of the receipt of
  the subscription rights will depend, in part, upon their valuation for federal
  income tax purposes.

       If the subscription rights are deemed to have a fair market value, the
  receipt of such rights will be taxable to you if you exercise your
  subscription rights, even though you would have received no cash from which to
  pay taxes on such taxable income.  We could also recognize a gain on the
  distribution of such subscription rights in an amount equal to their aggregate
  value.  In the opinion of Ferguson, whose opinion is not binding upon the IRS,
  the subscription rights do not have any value, based on the fact that such
  rights are acquired by the recipients without cost, are non-transferable and
  of short duration and afford the recipients the right only to purchase shares
  of the common stock at a price equal to its estimated fair market value, which
  will be the same price as the price paid by purchasers in the Community
  Offering for unsubscribed shares of common stock.  We encourage you to consult
  with your own tax advisors as to the tax consequences in the event that the
  subscription rights are deemed to have a fair market value.  Because the fair
  market value, if any, of the subscription rights issued in the Stock
  Conversion depends primarily upon the existence of certain facts rather than
  the resolution of legal issues, Housley Kantarian & Bronstein, P.C., has
  neither adopted the opinion of Ferguson as its own nor incorporated such
  opinion in its opinion issued in connection with Conversion.

       We have also obtained an opinion from KPMG Peat Marwick LLP to the effect
  that the tax effects of the Conversion under North Carolina tax laws will be
  substantially the same as described above with respect to federal income tax
  laws.

                                       20
<PAGE>
 
       THE FEDERAL AND STATE INCOME TAX DISCUSSION SET FORTH ABOVE DOES NOT
  PURPORT TO CONSIDER ALL ASPECTS OF FEDERAL AND STATE INCOME TAXATION WHICH MAY
  BE RELEVANT TO EACH ELIGIBLE ACCOUNT HOLDER, SUPPLEMENTAL ELIGIBLE ACCOUNT
  HOLDER AND OTHER MEMBER ENTITLED TO SPECIAL TREATMENT UNDER THE INTERNAL
  REVENUE CODE, SUCH AS TRUSTS, INDIVIDUAL RETIREMENT ACCOUNTS, OTHER EMPLOYEE
  BENEFIT PLANS, INSURANCE COMPANIES AND ELIGIBLE ACCOUNT HOLDERS, SUPPLEMENTAL
  ELIGIBLE ACCOUNT HOLDERS AND OTHER MEMBERS WHO ARE NOT CITIZENS OR RESIDENTS
  OF THE UNITED STATES.  DUE TO THE INDIVIDUAL NATURE OF TAX CONSEQUENCES, YOU
  ARE URGED TO CONSULT YOUR OWN TAX AND FINANCIAL ADVISOR AS TO THE EFFECT OF
  SUCH FEDERAL AND STATE INCOME TAX CONSEQUENCES ON YOUR OWN PARTICULAR FACTS
  AND CIRCUMSTANCES, INCLUDING THE RECEIPT AND EXERCISE OF SUBSCRIPTION RIGHTS,
  AND ALSO AS TO ANY OTHER TAX CONSEQUENCES ARISING OUT OF THE CONVERSION.

       Liquidation Account.  In the unlikely event of our complete liquidation
  in our present mutual form, each holder of a deposit account in the Bank would
  receive his pro rata share of any of our assets remaining after payment of
  claims of all creditors (including the claims of all depositors to the
  withdrawal value of their accounts).  His pro rata share of such remaining
  assets would be the same proportion of such assets as the value of his deposit
  account was to the total of the value of all deposit accounts in the Bank at
  the time of liquidation.

       After the Stock Conversion, each deposit account holder on a complete
  liquidation would have a claim of the same general priority as the claims of
  all other general creditors of the Bank.  Therefore, except as described
  below, his claim would be solely in the amount of the balance in his deposit
  account plus accrued interest.  He would have no interest in the value of the
  Bank above that amount.

       The Plan provides for the establishment, upon the completion of the Stock
  Conversion, of a special "liquidation account" for the benefit of Eligible
  Account Holders and Supplemental Eligible Account Holders in an amount equal
  to our net worth as of the date of our latest statement of financial condition
  contained in the prospectus to be used in connection with the Stock
  Conversion.  Each Eligible Account Holder (a person with a deposit account in
  the Bank on December 31, 1994) and each Supplemental Eligible Account Holder
  (a person with a qualifying deposit in the Bank on December 31, 1998) would be
  entitled, on a complete liquidation of the Converted Bank after completion of
  the Stock Conversion, to an interest in the liquidation account.  Each
  Eligible Account Holder would have an initial interest in such liquidation
  account for each deposit account held in the Bank on December 31, 1994 and
  each Supplemental Eligible Account Holder would have an initial interest in
  such liquidation account for each qualifying deposit held in the Bank on
  December 31, 1998.  The interest as to each qualifying deposit account would
  be in the same proportion of the total liquidation account as the balance of
  such qualifying deposit account was to the balance in all deposit accounts of
  Eligible Account Holders and Supplemental Eligible Account Holders on such
  date.  However, if the amount in the qualifying deposit account on any annual
  closing date (September 30) of the Bank subsequent to the relevant eligibility
  date is less than the amount in such account on the relevant eligibility date,
  or any subsequent closing date, then the Eligible Account Holder's or
  Supplemental Eligible Account Holder's interest in the liquidation account
  would be reduced from time to time by an amount proportionate to any such
  reductions, and such interest would cease to exist if he ceases to maintain an
  account at the Converted Bank that has the same Social Security number as
  appeared on his account(s) at the relevant eligibility date.  The interest in
  the liquidation account would never be increased, notwithstanding any increase
  in the related deposit account after the Stock Conversion.

       Any assets remaining after the above liquidation rights of Eligible
  Account Holders and Supplemental Eligible Account Holders were satisfied would
  be distributed to stockholders at that time.

       The Bank Conversion shall not be deemed to be a complete liquidation of
  the Converted Bank for purposes of the distribution of the liquidation
  account.  Upon consummation of the Bank Conversion, the liquidation account,
  and all rights and obligations of the Converted Bank in connection therewith,
  shall be continued.

       A merger, consolidation, sale of bulk assets or similar combination or
  transaction with an FDIC-insured institution in which we are not the surviving
  insured institution would not be considered to be a "liquidation" under

                                       21
<PAGE>
 
  which distribution of the liquidation account could be made. In such a
  transaction, the liquidation account would be assumed by the surviving
  institution.

       The creation and maintenance of the liquidation account will not restrict
  the use or application of any of our capital accounts, except that we may not
  declare or pay a cash dividend on, or repurchase any of, our capital stock if
  the effect of such dividend or repurchase would be to cause our retained
  earnings to be reduced below the aggregate amount then required for the
  liquidation account.

  SUBSCRIPTION RIGHTS

       Nontransferable subscription rights to subscribe for shares of the common
  stock have been issued to all persons entitled to subscribe for stock in the
  Subscription Offering at no cost to such persons.  The amount of the common
  stock which these parties may subscribe for will be determined, in part, by
  the total stock to be issued and the availability of stock for purchase under
  the categories set forth in the Plan.

            Preference categories have been established for the allocation of
       the common stock to the extent that shares are available. These
       categories, in order of preference, are as follows:

            Subscription Category No. 1 is reserved for the Bank's Eligible
       Account Holders, i.e., qualifying depositors of the Bank on December 31,
       1994, who, including individuals on a joint account or having the same
       address of the Bank's records, will each receive nontransferable
       subscription rights to subscribe for common stock in the Subscription
       Offering up to $1,000,000. See "-- Limitations on Purchase of Shares." If
       the exercise of subscription rights in this category results in an over-
       subscription, shares shall be allocated among subscribing Eligible
       Account Holders so as to permit each such Eligible Account Holder, to the
       extent possible, to purchase a number of shares sufficient to make his
       total allocation equal 100 shares or the amount subscribed for, whichever
       is less. Any shares not so allocated shall be allocated among the
       subscribing Eligible Account Holders on an equitable basis related to the
       amounts of their respective qualifying deposits, as compared to the total
       qualifying deposits of all subscribing Eligible Account Holders. TO
       ENSURE A PROPER ALLOCATION OF COMMON STOCK, EACH ELIGIBLE ACCOUNT HOLDER
       MUST LIST ON HIS STOCK ORDER FORM ALL ACCOUNTS IN WHICH HE HAS AN
       OWNERSHIP INTEREST. FAILURE TO LIST ALL SUCH DEPOSIT ACCOUNTS MAY CAUSE
       US TO BE UNABLE TO FILL ALL OR PART OF A SUBSCRIPTION ORDER. NEITHER THE
       COMPANY, THE BANK NOR ANY OF THEIR AGENTS SHALL BE RESPONSIBLE FOR ORDERS
       ON WHICH ALL DEPOSIT ACCOUNTS HAVE NOT BEEN FULLY AND ACCURATELY
       DISCLOSED. Subscription rights received by directors and officers of the
       Bank and their associates in this category based on their increased
       deposits in the Bank in the one-year period preceding December 31, 1994
       are subordinated to the subscription rights of other Eligible Account
       Holders.

            Subscription Category No. 2 is reserved for the Bank's tax-qualified
       employee stock benefit plans, i.e., the ESOP, which shall receive
       nontransferable subscription rights to purchase in the aggregate up to
       10% of the shares issued in the Stock Conversion and which is expected to
       purchase 8% of the common stock offered in the Stock Conversion. If all
       the shares of common stock offered in the Subscription Offering are
       purchased by Eligible Account Holders, then the ESOP will purchase shares
       in the open market following consummation of the Stock Conversion and
       will not purchase newly issued shares from the Company.

            Subscription Category No. 3 is reserved for the Bank's Supplemental
       Eligible Account Holders, i.e., qualifying depositors of the Bank on the
       last day of the calendar quarter preceding the Administrator's approval
       of the Plan (December 31, 1998) who, including individuals on a joint
       account or having the same address on the Bank's records, will each
       receive nontransferable subscription rights to subscribe for common stock
       in the Subscription Offering up to $1,000,000. See "-- Limitations on
       Purchase of Shares." If the exercise of subscription rights in this
       category results in an oversubscription, shares shall be allocated among
       subscribing Supplemental Eligible Account Holders, so as to permit each
       such Supplemental Eligible Account Holder, to the extent possible, to
       purchase a number of shares sufficient to make his total allocation equal
       100 shares or

                                       22
<PAGE>
 
       the amount subscribed for, whichever is less, and any shares not so
       allocated shall be allocated among the subscribing Supplemental Eligible
       Account Holders on an equitable basis related to the amounts of their
       respective qualifying deposits, as compared to the total qualifying
       deposits of all subscribing Supplemental Eligible Account Holders. TO
       ENSURE A PROPER ALLOCATION OF COMMON STOCK, EACH SUPPLEMENTAL ELIGIBLE
       ACCOUNT HOLDER MUST LIST ON HIS STOCK ORDER FORM ALL ACCOUNTS IN WHICH HE
       HAS AN OWNERSHIP INTEREST. FAILURE TO LIST ALL SUCH DEPOSIT ACCOUNTS MAY
       CAUSE US TO BE UNABLE TO FILL ALL OR PART OF A SUBSCRIPTION ORDER.
       NEITHER THE COMPANY, THE BANK NOR ANY OF THEIR AGENTS SHALL BE
       RESPONSIBLE FOR ORDERS ON WHICH ALL DEPOSIT ACCOUNTS HAVE NOT BEEN FULLY
       AND ACCURATELY DISCLOSED. Subscriptions in this Category No. 3 will be
       filled only to the extent that there are sufficient shares of common
       stock remaining after satisfaction of subscriptions by Category Nos. 1
       and 2.

           Subscription Category No. 4 is reserved for Other Members, i.e.,
       certain depositors and borrowers who are members of the Bank as of the
       Voting Record Date entitled to vote at the Special Meeting but who are
       not Eligible Account Holders or Supplemental Eligible Account Holders. To
       the extent then available following subscriptions by Eligible Account
       Holders, tax-qualified employee stock benefit plans and Supplemental
       Eligible Account Holders, Other Members, including individuals on a joint
       account or having the same address of the Bank's records, will receive,
       without payment therefor, nontransferable subscription rights to
       subscribe for common stock in the Subscription Offering up to $1,000,000.
       See "-- Limitations on Purchase of Shares." In the event that Other
       Members subscribe for a number of shares which, when added to the shares
       subscribed for by Eligible Account Holders, tax-qualified employee stock
       benefit plans and Supplemental Eligible Account Holders, is in excess of
       the total number of shares offered in the Stock Conversion, the
       subscriptions of such Other Members will be allocated pro rata among
       subscribing Other Members on an equitable basis as determined by the
       Board of Directors.

       We will make reasonable efforts to comply with the securities laws of all
  states in the United States in which persons entitled to subscribe for the
  common stock pursuant to the Plan reside. However, you will not be offered or
  allowed to purchase any common stock under the Plan if you reside in a foreign
  country or in a state of the United States with respect to which any or all of
  the following apply: (i) a small number of persons otherwise eligible to
  subscribe for shares under the Plan reside in such state or foreign country;
  (ii) the granting of subscription rights or the offer or sale of shares of
  common stock to you would require us or our employees to register, under the
  securities laws of such state, as a broker, dealer, salesman or agent or to
  register or otherwise qualify our securities for sale in such state or foreign
  country; and (iii) such registration or qualification would be impracticable
  for reasons of cost or otherwise. No payments will be made in lieu of the
  granting of subscription rights to you in such case.

  COMMUNITY OFFERING

       To the extent shares remain available for purchase after the Subscription
  Offering, we may offer any such remaining shares of the common stock to
  members of the general public to whom we deliver a copy of this Prospectus and
  a stock order form in the Community Offering. The Community Offering will not
  occur if shares of common stock are not available for purchase after
  satisfaction of all orders received in the Subscription Offering. The
  Community Offering, if one is held, will begin immediately after the
  Expiration Date, but may begin at any time during the Subscription Offering.
  The Community Offering may terminate without notice on or after the Expiration
  Date, but not later _____________, 1999 (or __________, 1999 if the
  Subscription Offering is fully extended), unless further extended with the
  consent of the FDIC and the Administrator. WE HAVE THE ABSOLUTE RIGHT TO
  ACCEPT OR REJECT ANY PURCHASES IN WHOLE OR IN PART IN THE COMMUNITY OFFERING
  IN OUR SOLE DISCRETION. WE PRESENTLY INTEND TO TERMINATE THE COMMUNITY
  OFFERING, IF ANY, AS SOON AS WE HAVE RECEIVED ORDERS FOR ALL SHARES AVAILABLE
  FOR PURCHASE IN THE STOCK CONVERSION.

       In the event an insufficient number of shares are available to fill
  orders in the Community Offering, we will allocate the available shares in our
  discretion so that a preference shall be given to natural persons and trusts
  of natural persons who are permanent residents of Alamance County, North
  Carolina. The term "resident" as used in relation to

                                       23
<PAGE>
 
  the preference afforded natural persons in Alamance County means any natural
  person who occupies a dwelling within Alamance County, has an intention to
  remain within Alamance County for a period of time (manifested by establishing
  a physical, ongoing, nontransitory presence within Alamance County) and
  continues to reside in Alamance County at the time of the Subscription and
  Community Offerings. We may utilize deposit or loan records or such other
  evidence provided to us to make the determination whether a person is residing
  in Alamance County. To the extent the person is a corporation or other
  business entity, the principal place of business or headquarters shall be
  within Alamance County. To the extent the person is a personal benefit plan,
  the circumstances of the beneficiary shall apply with respect to this
  definition. In the case of all other benefit plans, circumstances of the
  beneficiary shall be examined for purposes of this definition. In all cases,
  however, such determination shall be in our sole discretion.

       If the Community Offering extends beyond 45 days following the expiration
  of the Subscription Offering, sub  scribers will have the right to increase,
  decrease or rescind subscriptions for stock previously submitted.  Purchasers
  in the Community Offering, together with their associates and groups acting in
  concert, including individuals on joint accounts or having the same address on
  the Bank's records, are each eligible to purchase up to $1,000,000 of the
  common stock issued in the Offering.

       Except as noted below, cash and checks received in the Community Offering
  will be placed in a segregated savings account (insured by the FDIC up to the
  applicable $100,000 limit) established specifically for this purpose.
  Interest will be paid on orders made by check, in cash or by money order at
  the Bank's passbook rate from the date we receive the payment until the
  consummation of the Stock Conversion.  In the event that the Stock Conversion
  is not consummated for any reason, all funds submitted pursuant to the
  Community Offering will be promptly refunded with interest as described above.

       If the Community Offering is determined not to be feasible, we will
  immediately consult with the regulatory authorities to determine the most
  viable alternative available to effect the completion of the Stock Conversion.
  Should no viable alternative exist, we may terminate the Stock Conversion with
  the concurrence of the FDIC and the Administrator.  The Plan provides that the
  Stock Conversion must be completed within 12 months after approval of the Plan
  at the Special Meeting, which time period may be extended up to an additional
  12 months by amendment to the Plan.  In the event that the Stock Conversion is
  not effected, we will remain a North Carolina-chartered mutual savings bank,
  all subscription funds will be promptly returned to subscribers with interest
  earned thereon and all withdrawal authorizations will be canceled.  The
  completion of the Subscription and Community Offerings are subject to market
  conditions and other factors beyond our control.  No assurance can be given as
  to the length of time after approval of the Plan at the Special Meeting that
  will be required to complete the sale of the common stock to be offered in the
  Stock Conversion.  If delays are experienced, significant changes may occur in
  our estimated pro forma market value, together with corresponding changes in
  the offering price and the net proceeds realized from the sale of the common
  stock.  We would also incur substantial additional printing, legal and
  accounting expenses in completing the Stock Conversion.  In the event the
  Stock Conversion is terminated, we would be required to charge all Stock
  Conversion expenses against current income.

  SYNDICATED COMMUNITY OFFERING

       As part of the Community Offering, all shares of common stock not
  purchased in the Subscription and Community Offerings, if any, may be offered
  for sale to the general public in a Syndicated Community Offering through
  selected dealers to be formed and managed by Trident Securities.  The
  Syndicated Community Offering, if any, will be conducted to achieve the widest
  distribution of common stock subject to our right to reject orders in whole or
  in part in our sole discretion.  Neither Trident Securities nor any registered
  broker-dealer shall have any obligation to take or purchase any shares of the
  common stock in the Syndicated Community Offering.  Common stock sold in the
  Syndicated Community Offering will be sold at the same price as in the
  Subscription and Community Offerings.

       During the Syndicated Community Offering, selected dealers may only
  solicit indications of interest from their customers to place orders with the
  Company as of a certain date ("Order Date") for the purchase of shares of
  common

                                       24
<PAGE>
 
  stock. When and if Trident Securities and the Company believe that enough
  indications and orders have been received in the Offerings to consummate the
  Stock Conversion, Trident Securities will request, as of the Order Date,
  selected dealers to submit orders to purchase shares for which they have
  received indications of interest from their customers. Selected dealers will
  send confirmations of the orders to such customers on the next business day
  after the Order Date. Selected dealers may debit the accounts of their
  customers on a date which will be three business days from the Order Date
  ("Settlement Date"). Customers who authorize selected dealers to debit their
  brokerage accounts are required to have the funds for payment in their account
  on but not before the Settlement Date. On the Settlement Date, selected
  dealers will remit funds to the account that the Company established for each
  selected dealer. After payment has been received by us from selected dealers,
  funds will earn interest at our passbook savings rate until the consummation
  of the Stock Conversion. In the event the Stock Conversion is not consummated
  as described above, funds with interest will be returned promptly to the
  selected dealers, who, in turn, will promptly credit its customers' brokerage
  account.

       The Syndicated Community Offering, if any, will terminate no more than 45
  days following the completion of the Subscription Offering, unless extended
  with the approval of the Administrator.  In the event the Community Offering
  is extended beyond 45 days following the expiration of this Subscription
  Offering, subscribers will have the right to increase, decrease or rescind
  subscriptions for stock previously submitted.  The Syndicated Community
  Offering may run concurrently with the Subscription and Community Offerings or
  subsequent to such offerings.

  ESTABLISHMENT OF THE FOUNDATION

       General.  Pursuant to the Plan, we will establish a charitable
  foundation, 1st State Bank Foundation, Inc., in connection with the Stock
  Conversion.  The Foundation will be dedicated to charitable and educational
  purposes within our market area.  We will contribute up to 150,000 shares of
  common stock to fund the Foundation.  The contribution of common stock to the
  Foundation will dilute the interests of stockholders and will materially
  reduce our earnings during the fiscal year ending September 30, 1999, the year
  in which the Foundation will be established.

       Purposes of the Foundation.   The purpose of the Foundation is to provide
  funding to support charitable causes and community development activities.  In
  recent years, we have emphasized community lending and development activities
  within the communities that we serve.  We are forming the Foundation as a
  complement to our existing community reinvestment act activities and not as a
  replacement for those activities.  While we intend to continue to emphasize
  community lending and development activities following the Conversion, such
  activities are not our sole corporate purpose.  The Foundation, conversely,
  will be completely dedicated to community activities and the promotion of
  charitable causes, and may be able to support such activities in ways that are
  not currently available to us. We believe that the Foundation will enable us
  to assist our local community in areas beyond community lending and
  development.  We believe the establishment of a charitable foundation is
  consistent with our commitment to community service.  We further believe that
  the funding of the Foundation with our common stock is a means of enabling the
  communities we serve to share in our growth and success long after the
  completion of the Conversion.  The Foundation will accomplish that goal by
  providing for continued ties between the Foundation and Bank, thereby forming
  a partnership with our community.  The establishment of the Foundation also
  will enable us to develop a unified charitable donation strategy and will
  centralize the responsibility for administration and allocation of corporate
  charitable funds.

       Structure of the Foundation. The Foundation will be incorporated under
  North Carolina law as a nonprofit corporation.  The Foundation's board of
  directors will be comprised of individuals who also serve as our directors or
  officers.  The members of the Foundation, who are comprised of its directors,
  will elect the directors at the annual meeting of the Foundation.  Directors
  will be elected annually.  Directors of the Foundation will not receive any
  additional compensation for serving as such.  The articles of incorporation of
  the Foundation provide that the Foundation is organized exclusively for
  charitable purposes, including community development, as set forth in Section
  501(c)(3) of the Internal Revenue Code.  The Foundation's articles of
  incorporation further provide that no part of the net earnings of the
  Foundation will inure to the benefit of, or be distributable to its directors,
  officers or members.  In addition, any person who is a director, officer or
  employee of the Bank, or has the power to direct its management or policies,
  or

                                       25
<PAGE>
 
  otherwise owes a fiduciary duty to the Bank (including the Company's
  directors), and will also serve as a director, officer or employee of the
  Foundation, is subject to conflicts of interest regulations.

       The authority for the affairs of the Foundation will be vested in the
  board of directors of the Foundation. The directors of the Foundation will be
  responsible for establishing the policies of the Foundation with respect to
  grants or donations by the Foundation, consistent with the purposes for which
  the Foundation was established.  Although no formal policy governing
  Foundation grants exists at this time, the Foundation's board of directors
  will adopt such a policy upon establishment of the Foundation.   As directors
  of a nonprofit corporation, directors of the Foundation will at all times be
  bound by their fiduciary duty to advance the Foundation's charitable goals, to
  protect the assets of the Foundation and to act in a manner consistent with
  the charitable purpose for which the Foundation is established.  As a
  condition to receiving the approval of the FDIC to the Conversion, the
  Foundation will be required to commit to the FDIC that all shares of common
  stock held by the Foundation will be voted in the same ratio as all other
  shares of common stock on all proposals considered by our stockholders;
  provided, however, that, consistent with such condition, the FDIC would waive
  this voting restriction under certain circumstances.  See " -- Tax
  Considerations."

       The Foundation's place of business will be located at our administrative
  offices, and initially the Foundation is expected to have no employees but
  will utilize our staff.  The board of directors of the Foundation will appoint
  such officers as may be necessary to manage the operations of the Foundation.
  In this regard, it is expected that the Bank will be required to provide the
  FDIC with a commitment that, to the extent applicable, the Bank will comply
  with the affiliate restrictions set forth in Sections 23A and 23B of the
  Federal Reserve Act with respect to any transactions between the Bank and the
  Foundation.

       The Foundation will receive working capital from any dividends that may
  be paid on the common stock in the future, and subject to applicable federal
  and state laws, loans collateralized by the common stock or from the proceeds
  of the sale of any of the common stock in the open market from time to time as
  may be permitted to provide the Foundation with additional liquidity.  As a
  private foundation under Section 501(c)(3) of the Code, the Foundation will be
  required to distribute annually in grants or donations, a minimum of 5% of the
  average fair market value of its net investment assets.

       Dilution of Stockholders' Interests.  We propose to contribute up to
  150,000 shares of common stock to the Foundation.  That number represents
  between 10.5% and 8.0% of the number of shares of common stock that will be
  outstanding following consummation of the Stock Conversion at the minimum and
  maximum, respectively, of the Estimated Valuation Range.  At the purchase
  price of $20.00 per share, the contribution to the Foundation will have a
  value of up to $3.0 million.  At the midpoint of the Estimated Valuation
  Range, upon completion of the Stock Conversion and establishment of the
  Foundation, the Company will have 1,650,000 shares of common stock issued and
  outstanding, of which the Foundation will own up to 150,000 shares, or 9.1%.
  As a result, your ownership and voting interests in the Company will be
  diluted.  See "Pro Forma Data."

       Impact on Earnings.  The contribution of common stock to the Foundation
  will have an adverse impact on our earnings in the year in which the
  contribution is made.  We will recognize the full expense in the amount of the
  contribution of common stock to the Foundation in the quarter in which it
  occurs, which is expected to be the quarter ending March 31 or June 30, 1999.
  The amount of the contribution will be up to $3.0 million.  The contribution
  expense will be partially offset by the tax benefit related to the expense.
  We anticipate that the contribution to the Foundation will be tax deductible,
  subject to an annual limitation based on 10% of annual taxable income.
  Assuming a contribution of $3.0 million in common stock, we estimate an after
  tax expense of $2.0 million (based on a 34% marginal federal tax rate).  If
  the Foundation had been established at September 30, 1998, we would have
  reported net income of $541,000 for the year ended September 30, 1998 rather
  than reporting net income of $2.5 million.  We cannot predict earnings for
  1999 but expect that the establishment and funding of the Foundation will
  materially reduce our earnings for that year.  However, in light of the
  expected contribution to the Foundation, we do not expect in the future to
  make other than nominal charitable contributions within the communities we
  serve.  In addition, we do not currently anticipate making additional
  contributions to the Foundation within the first five years following the
  initial contribution.

                                       26
<PAGE>
 
       Tax Considerations.  We anticipate that the Foundation will qualify as a
  Section 501(c)(3) exempt organization under the Internal Revenue Code and will
  be classified as a private foundation.  The Foundation will submit a request
  to the IRS to be recognized as an exempt organization.  Regulatory authorities
  require that common stock issued to the Foundation be voted in the same ratio
  as all other shares of our common stock on all proposals considered by our
  stockholders.  In the event that the Company or the Foundation receives an
  opinion of its legal counsel that compliance with the voting restriction would
  have the effect of causing the Foundation to lose its tax-exempt status, or
  otherwise have a material and adverse tax consequence on the Foundation, or
  subject the Foundation to an excise tax under Section 4941 of the Code, the
  FDIC and the Administrator shall waive such voting restriction upon submission
  of a legal opinion by the Company or the Foundation that is satisfactory to
  the FDIC and the Administrator.  We further anticipate that we will be
  entitled to a deduction in the amount of the fair market value of the stock at
  the time of the contribution, subject to an annual limitation based on 10% of
  annual taxable income.  However, we would be able to carry forward any unused
  portion of the deduction for five years following the contribution.  Thus,
  while we would receive a tax benefit of approximately $1.0 million in the year
  ending September 30, 1999, based upon a contribution of $3.0 million of common
  stock, we are permitted under the Internal Revenue Code to carry over the
  excess contribution in the five following years.  We estimate that for federal
  income tax purposes, a substantial portion of the deduction should be
  deductible over the six-year period. Although we anticipate that we will be
  entitled to the deduction of the charitable contribution, we cannot assure you
  that the IRS will recognize the Foundation as a Section 501(c)(3) exempt
  organization or that the deduction will be permitted. In such event, the tax
  benefit related to the Foundation would have to be fully expensed, resulting
  in further reduction in earnings in the year in which the IRS makes such a
  determination.

       Comparison of Valuation and Other Factors Assuming the Foundation is Not
  Established as Part of the Stock Conversion.  The establishment of the
  Foundation was taken into account by Ferguson in determining our estimated pro
  forma market value.  The number of shares of common stock being offered in the
  Offering and the Purchase Price are based upon the independent appraisal
  conducted by Ferguson of our estimated pro forma market value.  The Estimated
  Valuation Range is currently between $25.5 million and $34.5 million, with a
  midpoint of $30.0 million.  Ferguson has indicated that the establishment of
  the Foundation reduced the independent appraisal by $5.0 million at the
  midpoint of the Estimated Valuation Range, and that if we had not established
  the Foundation in connection with the Stock Conversion then the independent
  valuation would have been increased to a range of from $29.8 million to $40.3
  million with a midpoint of $35.0 million.  The pro forma price to book ratio
  and the pro forma price to annualized earnings ratio, at and for the year
  ended September 30, 1998, are 63.5% and 10.5x, respectively, at the midpoint
  of the Estimated Valuation Range.  In the event that the Stock Conversion did
  not include the Foundation,  Ferguson has estimated that the Independent
  Valuation would have been $35.0 million at the midpoint, which would have
  resulted in a pro forma price to book ratio and a pro forma price to earnings
  ratio of 62.9% and 10.8x, respectively.  See "Comparison of Valuation and Pro
  Forma Information with No Foundation."

       The decrease in the amount of common stock being offered as a result of
  the contribution of common stock to the Foundation will not have a significant
  effect on the Company's or the Bank's capital position.  The Bank's regulatory
  capital is significantly in excess of its regulatory capital requirements and
  will further exceed such requirements following the Stock Conversion.  The
  Bank's leverage and risk-based capital ratios at September 30, 1998 were 9.0%
  and 15.8%, respectively.  Assuming the sale of shares at the midpoint of the
  Estimated Valuation Range, the Bank's pro forma leverage and risk-based
  capital ratios at September 30, 1998 would be 13.0% and 22.3%, respectively.
  On a consolidated basis, our pro forma stockholders' equity would be $52.0
  million, or approximately 16.6% of pro forma consolidated assets, assuming the
  sale of shares at the midpoint of the Estimated Price Range.  Pro forma
  stockholders' equity per share and pro forma net income per share would be
  $31.51 and $1.90, respectively.  If we were not establishing the Foundation in
  the Stock Conversion, based on Ferguson's estimate, our pro forma
  stockholders' equity would be approximately $55.7 million, or approximately
  17.5% of pro forma consolidated assets at the midpoint of the estimated value,
  and pro forma stockholders' equity per share and pro forma net income per
  share would be $31.84 and $1.86, respectively.  See "Comparison of Valuation
  and Pro Forma Information with No Foundation."

       Regulatory Conditions Imposed on the Foundation.  Establishment of the
  Foundation is subject to certain conditions agreed to by the Foundation in
  writing as a condition to receiving the FDIC's non-objection to and approval

                                       27
<PAGE>
 
  of the Stock Conversion, including the following: (i) the Foundation will be
  subject to examination by the FDIC and the Administrator; (ii) the Foundation
  must comply with supervisory directives imposed by the FDIC and the
  Administrator; (iii) the Foundation will operate in accordance with written
  policies adopted by the board of directors, including a conflict of interest
  policy; and (iv) any shares of common stock held by the Foundation must be
  voted in the same ratio as all other outstanding shares of common stock on all
  proposals considered by our stockholders.  The FDIC and the Administrator
  would waive the voting restriction under certain circumstances (and subject to
  additional conditions) if compliance with the voting restriction would: (a)
  cause a violation of the law of the State of North Carolina; (b) would cause
  the Foundation to lose its tax-exempt status or otherwise have a material and
  adverse tax consequence on the Foundation; or (c) would cause the Foundation
  to be subject to an excise tax under Section 4941 of the Code.  In order to
  obtain a waiver, the Foundation's legal counsel would be required to render an
  opinion satisfactory to the FDIC and the Administrator.  There can be no
  assurances that a legal opinion addressing these issues could be rendered, or
  if rendered, that the FDIC and the Administrator would grant unconditional
  waivers of the voting restriction.  In no event would the voting restriction
  survive the sale of shares of the common stock held by the Foundation.

  SUBSCRIPTIONS FOR STOCK IN SUBSCRIPTION AND COMMUNITY OFFERINGS

       Expiration Date.  The Subscription Offering will expire at 12:00 Noon,
  Eastern Time, on __________, 1999 (referred to in this Prospectus as the
  "Expiration Date") unless extended by the Board of Directors of the Bank
  for up to an additional 45 days, to no later than _________, 1999.Subscription
  rights not exercised prior to the Expiration Date will be void. The Community
  Offering, if any, may terminate at any time without notice, but may not
  terminate later than ____________, 1999.

       We will not execute orders until at least the minimum number of shares of
  common stock offered hereby have been subscribed for or sold.  If the minimum
  number of shares of common stock have not been subscribed for or sold within
  45 days of the end of the Subscription Offering (unless such period is
  extended with consent of the Administrator), all funds delivered to us
  pursuant to the Subscription Offering will be promptly returned to the
  subscribers with interest and all charges to savings accounts will be
  rescinded.

       Use of Stock Order Forms and Certification Forms.  Rights to subscribe
  may only be exercised by completion of stock order forms and certification
  forms.  If you receive a stock order form and you desire to subscribe for
  shares of stock, you must do so prior to the Expiration Date by delivering (by
  mail or in person) to any office of the Bank a properly executed and completed
  stock order form and certification form, together with full payment for all
  shares for which the subscription is made.  All checks or money orders must be
  made payable to "1st State Bancorp, Inc."  No photocopies or faxes of stock
  order forms or payment by wire transfer will be accepted.  The stock order
  form and certification form must be received by the Expiration Date. All
  subscription rights under the Plan will expire on the Expiration Date, whether
  or not we have been able to locate each person entitled to such subscription
  rights. ONCE TENDERED, SUBSCRIPTION ORDERS CANNOT BE REVOKED.

       Each subscription right may be exercised only by the person to whom it is
  issued and only for his or her own account.  THE SUBSCRIPTION RIGHTS GRANTED
  UNDER THE PLAN ARE NONTRANSFERABLE.  IF YOU ATTEMPT TO TRANSFER YOUR
  SUBSCRIPTION RIGHTS, YOU MAY LOSE THE RIGHT TO SUBSCRIBE FOR STOCK IN THE
  STOCK CONVERSION AND MAY BE SUBJECT TO OTHER SANCTIONS AND PENALTIES IMPOSED
  BY THE ADMINISTRATOR.  If you subscribe for shares, you will be required to
  represent to us that you are purchasing such shares for your own account and
  that you have no agreement or understanding with any other person for the sale
  or transfer of your shares.

       In the event stock order forms (i) are not delivered and are returned to
  us by the United States Postal Service or we are unable to locate the
  addressee, or (ii) are not returned or are received after the Expiration Date,
  or (iii) are defectively completed or executed, or (iv) are not accompanied by
  the full required payment for the shares subscribed for (including instances
  where a savings account or certificate balance from which withdrawal is
  authorized is insufficient to fund the amount of such required payment), the
  subscription rights of the person to whom such rights

                                       28
<PAGE>
 
  have been granted will lapse as though such person failed to return the
  completed stock order form within the time period specified. However, we may,
  but will not be required to, waive any irregularity on any stock order form or
  require the submission of corrected stock order forms or the remittance of
  full payment for subscribed shares by such date as we may specify. Our
  interpretation of the terms and conditions of the Plan and of the stock order
  form will be final.

       Payment for Shares.  Payment for all subscribed shares of common stock
  will be required to accompany all completed stock order forms for
  subscriptions to be valid.  Payment for subscribed shares may be made (i) in
  cash, if delivered in person, (ii) by check or money order, or (iii) by
  authorization of withdrawal from deposit accounts maintained with the Bank.
  Appropriate means by which such withdrawals may be authorized are provided in
  the stock order form.  Once such a withdrawal has been authorized, you may not
  use any of the designated withdrawal amount for any purpose other than to
  purchase stock for which subscription has been made while the Plan remains in
  effect.  In the case of payments authorized to be made through withdrawal from
  deposit accounts, all sums authorized for withdrawal will continue to earn
  interest at the contract rate until the date of consummation of the sale.  In
  the case of payments made in cash or by check or money order such funds will
  be placed in a single segregated savings account established specifically for
  this purpose (with the account as a whole insured by the FDIC up to the
  applicable $100,000 limit) and interest will be paid at our passbook rate from
  the date payment is received until the Stock Conversion is completed or
  terminated.  Interest penalties for early withdrawal applicable to certificate
  accounts will not apply to withdrawals authorized for the purchase of shares.
  If a partial withdrawal results in a certificate account with a balance less
  than the applicable minimum balance requirement, the certificate evidencing
  the remaining balance will earn interest at the Bank's passbook rate
  subsequent to the withdrawal.  An executed stock order form, once received by
  us, may not be modified, amended or rescinded without our consent, unless the
  Stock Conversion is not completed within 45 days of the termination of the
  Subscription Offering.  If an extension of the period of time to complete the
  Stock Conversion is approved by the Administrator, subscribers will be
  resolicited and must affirmatively reconfirm their orders prior to the
  expiration of the resolicitation offering, or their subscription funds will be
  promptly refunded. At this time, subscribers may also modify or cancel their
  subscription at that time. Interest will be paid on such funds at the Bank's
  passbook rate during the 45-day period and any approved extension period.

       If you own a self-directed IRA, you may use the assets of such IRA to
  purchase shares of common stock in the Offering, provided that such self-
  directed IRA is not maintained at the Bank.  If you maintain an IRA at the
  Bank, you must have your account transferred to an unaffiliated institution or
  broker to purchase shares of common stock in the Offering.  If you are
  interested in using funds in a Bank IRA to purchase common stock, you must
  make arrangements with the Stock Information Center at (336) ___-____ no later
  than ___________, 1999 so that the necessary forms may be forwarded for
  execution.

       The ESOP will not be required to pay for the shares subscribed for at the
  time it subscribes, but may pay for such shares upon consummation of the
  Subscription and Community Offerings, if all shares are sold, or upon
  consummation of any subsequent offering, if shares remain to be sold in such
  an offering.

       Shares Purchased.  Certificates representing shares of the common stock
  will be delivered to subscribers as soon as practicable after closing of the
  Stock Conversion.  Shares sold prior to receipt of certificates for the common
  stock are the responsibility of the purchaser.

  PLAN OF DISTRIBUTION AND MARKETING AGENT

       Our officers are available at our offices to provide offering materials,
  to answer questions (but only to the extent such information is derived from
  this Prospectus) and to receive completed stock order forms and certification
  forms.  None of our directors, officers or employees will receive any
  commissions or other compensation for their efforts in connection with sales
  of shares of the common stock.  ALTHOUGH INFORMATION REGARDING THE STOCK
  OFFERING IS AVAILABLE AT OUR OFFICES, AN INVESTMENT IN THE COMMON STOCK IS NOT
  A DEPOSIT, AND THE COMMON STOCK IS NOT FEDERALLY INSURED.

                                       29
<PAGE>
 
       Our directors, officers and employees who will be involved in selling
  stock are expected to be exempt from the requirement to register with the SEC
  as broker-dealers within the meaning of Rule 3a4-1 under the Exchange Act.
  Such persons will qualify under the safe harbor provisions of that rule on the
  basis of paragraphs (a)(4)(ii) and/or (iii), i.e., management expects that
  such persons either (x) will perform substantial duties for the Company in its
  business, will not otherwise be broker-dealers and are not expected to
  participate in another offering in the next twelve months or (y) will limit
  their activities to preparing written communications, responding to customer
  inquiries and/or performing ministerial/clerical functions.

       We have engaged Trident Securities as financial advisor to provide sales
  assistance in connection with the Subscription and Community Offerings.  The
  services of Trident Securities will include, but are not limited to, (i)
  training and educating our employees who will be performing certain
  ministerial functions in the Subscription and Community Offerings regarding
  the mechanics and regulatory requirements of the stock sales process and the
  solicitation of proxies from members, (ii) providing employees to staff the
  Stock Information Center, assisting our customers and interested stock
  purchasers and keeping records of orders for shares of common stock, and (iii)
  supervising our sales efforts, including preparation of marketing materials.
  For all its services rendered in the Stock Conversion, Trident Securities will
  receive a commission equal to 1.50% of the aggregate dollar amount of common
  stock sold in the Subscription and Community Offerings, excluding any shares
  of stock sold to our directors, executive officers and the ESOP.
  Additionally, commissions will be excluded on shares sold to "associates" (as
  defined in the Plan) of our directors and executive officers.  In the event
  common stock is sold by other NASD member firms under selected dealer's
  agreements, the aggregate commissions to be received by Trident Securities and
  selected dealers will be agreed upon jointly by us and Trident Securities to
  reflect market requirements at the time of the stock allocation in the
  Syndicated Community Offering and shall not exceed 6%. Trident Securities will
  also be reimbursed for its reasonable out-of-pocket expenses in an amount not
  to exceed $10,000 and its legal fees in an amount not to exceed $27,500. We
  have agreed to indemnify Trident Securities for reasonable costs and expenses
  in connection with certain claims or liabilities, including certain
  liabilities under the Securities Act.

  STOCK PRICING AND NUMBER OF SHARES TO BE ISSUED

       We retained Ferguson, which is experienced in the evaluation and
  appraisal of savings institutions involved in the conversion process, to
  prepare an appraisal of our estimated pro forma market value.  Prior to the
  Conversion, we did not have any business relationship with Ferguson.  Ferguson
  will receive a fixed fee of $30,000 for its appraisal and other services.  We
  have agreed to indemnify Ferguson under certain circumstances against any
  losses, damages, expenses or liability arising out of our engagement of
  Ferguson for the appraisal.

       Ferguson has determined as of October 30, 1998 that the estimated pro
  forma market value of the stock to be issued in the Stock Conversion was
  $30,000,000.  In determining the reasonableness and adequacy of the appraisal
  submitted by Ferguson, the Boards of Directors of the Bank and the Company
  reviewed with Ferguson the methodology and the appropriateness of assumptions
  used by Ferguson in preparing the appraisal.  In consultation with Trident
  Securities, we have determined to offer the shares in the Stock Conversion at
  the Purchase Price of $20.00 per share.  The price per share was determined
  based on a number of factors, including the market price per share of the
  stock of other financial institutions.  With the consent of the Administrator
  and the FDIC, however, the appraiser may establish a range of value for the
  stock of approximately 15% on either side of the estimated value to allow for
  fluctuations in the aggregate value of the stock due to changes in the market
  and other factors from the time of commencement of the Subscription Offering
  until completion of the Community Offering.  Accordingly, Ferguson has
  established a range of value of from $25,500,000 to $34,500,000 for the Stock
  Conversion.  Ferguson will either confirm the continuing validity of its
  appraisal or provide an updated appraisal immediately prior to the completion
  of the Stock Conversion.

       The appraisal has been prepared by Ferguson in reliance upon the
  information contained in this Prospectus, including our consolidated financial
  statements.  Ferguson also considered the following factors, among others:
  the present and projected operating results and financial condition of the
  Bank and the economic and demographic conditions in the Bank's and the
  Company's existing market area; certain historical, financial and other
  information

                                       30
<PAGE>
 
relating to the Bank and the Company; a comparative evaluation of the operating
and financial statistics of the Bank and the Company with those of other
similarly situated savings institutions located in North Carolina and other
regions of the United States; the aggregate size of the offering of common
stock; the impact of the Stock Conversion on the Bank's and the Company's net
worth and earnings potential; the proposed dividend policy of the Company and
the Bank; and the trading market for securities of comparable institutions and
general conditions in the market for such securities.

     Should it be determined at the close of the offering that the aggregate
pro forma market value of the common stock is higher or lower than $30.0
million, but is nonetheless within the Estimated Valuation Range or within 15%
above the maximum of such range, we will make an appropriate adjustment by
raising or lowering the total number of shares issued (within a range from
1,275,000 shares to 1,983,750 shares). Unless permitted by the Company or
otherwise required by the FDIC or the Administrator, we will not resolicit
subscribers and other purchasers because of any such change in the number of
shares to be issued unless the aggregate purchase price of the common stock sold
in the Stock Conversion is below the minimum of the Estimated Valuation Range or
is more than $39,675,000 (i.e., 15% above the maximum of the Estimated Valuation
Range). If the aggregate purchase price falls outside the range of from
$25,500,000 to $39,675,000, you will be resolicited and given the opportunity to
continue your orders, in which case you will need to affirmatively reconfirm
your subscriptions prior to the expiration of the resolicitation, or your
subscription funds will be promptly refunded with interest at our passbook rate.
You will also be given the opportunity to increase, decrease or rescind your
orders. Any change in the Estimated Valuation Range must be approved by the
Administrator. THE ESTABLISHMENT OF ANY NEW PRICE RANGE MAY BE EFFECTED WITHOUT
A RESOLICITATION OF VOTES FROM OUR MEMBERS TO APPROVE THE PLAN.

     THE APPRAISAL IS NOT INTENDED, AND MUST NOT BE CONSTRUED, AS A
RECOMMENDATION OF ANY KIND AS TO THE ADVISABILITY OF PURCHASING THE COMMON
STOCK. IN PREPARING THE VALUATION, FERGUSON HAS RELIED UPON AND ASSUMED THE
ACCURACY AND COMPLETENESS OF FINANCIAL AND STATISTICAL INFORMATION PROVIDED BY
US. FERGUSON DID NOT INDEPENDENTLY VERIFY THE FINANCIAL STATEMENTS AND OTHER
INFORMATION PROVIDED BY US, NOR DID FERGUSON VALUE INDEPENDENTLY OUR ASSETS AND
LIABILITIES. THE VALUATION CONSIDERS US ONLY AS A GOING CONCERN AND SHOULD NOT
BE CONSIDERED AS AN INDICATION OF OUR LIQUIDATION VALUE. MOREOVER, BECAUSE THE
APPRAISAL IS BASED UPON ESTIMATES AND PROJECTIONS OF A NUMBER OF MATTERS WHICH
ARE SUBJECT TO CHANGE, THE MARKET PRICE OF THE COMMON STOCK COULD DECLINE BELOW
$20.00 PER SHARE. COPIES OF THE APPRAISAL REPORT OF FERGUSON SETTING FORTH THE
METHOD AND ASSUMPTIONS FOR THE APPRAISAL ARE ON FILE AND AVAILABLE FOR
INSPECTION AT THE OFFICES SET FORTH UNDER "ADDITIONAL INFORMATION" AND AT OUR
OFFICES. ANY SUBSEQUENT UPDATED APPRAISAL WILL BE FILED WITH THE SEC AND WILL BE
AVAILABLE FOR INSPECTION.

LIMITATIONS ON PURCHASE OF SHARES

     The Plan provides for certain additional limitations to be placed upon the
purchase of shares by eligible subscribers and others in the Stock Conversion.
Each subscriber must subscribe for a minimum of 25 shares. The ESOP may purchase
up to an aggregate of 10% of the shares of the common stock to be issued in the
Stock Conversion and is expected to purchase 8% of such shares. Except for the
ESOP, no Eligible Account Holder, Supplemental Eligible Account Holder or Other
Member, including individuals on a joint account or having the same address on
the Bank's records, may purchase in their capacity as such in the Subscription
Offering more than 50,000 shares, or $1,000,000, of common stock. No person,
including associates of and persons acting in concert with such person,
including individuals on a joint account or having the same address on the
Bank's records, may purchase in the Community Offering more than 50,000 shares,
or $1,000,000, of common stock. No person, including associates of and persons
acting in concert with such person (other than the ESOP), including individuals
on a joint account or having the same address on the Bank's records, may
purchase in the Stock Conversion more than $1,000,000, or 50,000 shares of
common stock. Shares purchased by the ESOP and attributable to a participant
thereunder shall not be aggregated with shares purchased by such participant or
any other purchaser of common stock in the Stock Conversion. For purposes of the
Plan, our directors are not deemed to be associates or a group acting in concert
solely by reason of their Board membership.

                                       31
<PAGE>
 
     Subject to any required regulatory approval and the requirements of
applicable laws and regulations, but without further approval of our members,
the purchase limitations may be increased or decreased at our sole discretion at
any time. If such amount is increased, subscribers for the maximum amount will
be given the opportunity to increase their subscriptions up to the then
applicable limit, subject to the rights and preferences of any person who has
priority subscription rights. In the event that the purchase limitation is
decreased after commencement of the Subscription and Community Offerings, the
orders of any person who subscribed for the maximum number of shares of common
stock shall be decreased by the minimum amount necessary so that such person
shall be in compliance with the then maximum number of shares permitted to be
subscribed for by such person.

     The term "associate" of a person is defined to mean: (i) any corporation
or organization (other than the Bank, the Company, or a majority-owned
subsidiary of the Bank or the Company) of which such person is an officer or
partner or is directly or indirectly the beneficial owner of 10% or more of any
equity securities; (ii) any trust or other estate in which such person has a
substantial beneficial interest or as to which such person serves as a trustee
or in a similar fiduciary capacity, except that such term shall not include any
tax-qualified employee stock benefit plan of ours in which such person has a
substantial beneficial interest or serves as a trustee or in a similar fiduciary
capacity; and (iii) any relative or spouse of such person, or any relative of
such spouse, who either has the same home as such person or who is a director of
the Bank or the Company or any of their subsidiaries. Directors are not treated
as associates solely because of their Board membership.

     The term "acting in concert" means (i) knowing participation in a joint
activity or interdependent conscious parallel action towards a common goal
whether or not pursuant to an express agreement; or (ii) a combination or
pooling of voting or other interests in the securities of an issuer for a common
purpose pursuant to any contract, understanding, relationship, agreement or
other arrangement, whether written or otherwise. We may presume that certain
persons are acting in concert based upon, among other things, joint account
relationships, common addresses and the fact that such persons have filed joint
Schedule 13Ds with the SEC with respect to other companies.

     Each person purchasing common stock in the Stock Conversion shall be
deemed to confirm that such purchase does not conflict with the purchase
limitations under the Plan or otherwise imposed by law, rule or regulation. In
the event that such purchase limitations are violated by any person (including
any associate or group of persons affiliated or otherwise acting in concert with
such person), we shall have the right to purchase from such person at the
aggregate purchase price all shares acquired by such person in excess of such
purchase limitations or, if such excess shares have been sold by such person, to
receive the difference between the aggregate purchase price paid for such excess
shares and the price at which such excess shares were sold by such person. Our
right to purchase such excess shares shall be assignable by us. In addition,
persons who violate the purchase limitations may be subject to sanctions and
penalties imposed by the Administrator.

     In addition, under guidelines of the NASD, members of the NASD and their
associates are subject to certain restrictions on the transfer of securities
purchased in accordance with subscription rights and to certain reporting
requirements upon purchase of such securities.

     Depending upon market conditions, the Boards of Directors of the Company
and the Bank, with the approval of the Administrator, may increase or decrease
any of the above purchase limitations. In the event of such an increase or
decrease, no further approval of our members would be required. North Carolina
regulations authorize a plan of conversion to provide a maximum purchase
limitation of a percentage not to exceed 5% except for tax-qualified employee
stock benefit plans which may purchase in the aggregate not more than 10%.

                                       32
<PAGE>
 
RESTRICTIONS ON REPURCHASE OF STOCK

     Upon consummation of the Bank Conversion, our ability to repurchase our
capital stock will be governed by the Federal Reserve Board's regulations. Under
the Federal Reserve Board's regulations, any bank holding company that is not
well-capitalized and not in generally satisfactory condition must notify the
Federal Reserve Board before purchasing or redeeming its equity securities if
the gross consideration for the purchase or redemption, when aggregated with the
net consideration paid by the company for all purchases and redemptions during
the preceding 12 months, is equal to 10% or more of the company's consolidated
net worth. The Federal Reserve Board may disapprove a proposed purchase or
redemption if it finds that the proposal would constitute an unsafe or unsound
practice or would violate any directive of, condition imposed by or written
agreement with, the Federal Reserve Board. Under the Federal Reserve Board's
regulations, no such prior notice of repurchases is required to be given by a
bank holding company that has received one of the two highest examination
ratings at its most recent supervisory inspection, is not the subject of any
unresolved supervisory issues and is, and after giving effect to the proposed
repurchase will continue to be, well-capitalized. We do not have any specific
plans regarding possible stock repurchases during the first year following the
Stock Conversion.

LIMITATIONS ON RESALES BY MANAGEMENT

     Shares of the common stock purchased by our directors or executive
officers and those of the Company in the Stock Conversion will be subject to the
restriction that such shares may not be sold for a period of one year following
completion of the Stock Conversion, except in the event of the death of the
original purchaser or in any exchange of such shares in connection with a merger
or acquisition of the Company approved by the applicable regulatory authorities.
Accordingly, shares of the common stock issued to directors and executive
officers shall bear a legend giving appropriate notice of the restriction
imposed upon it. In addition, we will give appropriate instructions to the
transfer agent for the common stock with respect to the applicable restriction
for transfer of any restricted stock. Any shares issued to directors and
executive officers as a stock dividend, stock split or otherwise with respect to
restricted stock shall be subject to the same restrictions. Shares acquired
otherwise than in the Stock Conversion, such as under the stock option plan,
would not be subject to such restrictions. To the extent directors and executive
officers are deemed affiliates of the Company, all shares of the common stock
acquired by such directors and officers will be subject to certain resale
restrictions and may be resold pursuant to Rule 144 under the Securities Act.
See "Regulation -- Regulation of the Company -- Federal Securities Law."

INTERPRETATION AND AMENDMENT OF THE PLAN

     To the extent permitted by law, our interpretations of the Plan will be
final. The Plan provides that our Board of Directors shall have the sole
discretion to interpret and apply the provisions of the Plan to particular facts
and circumstances and to make all determinations necessary or desirable to
implement such provisions, including but not limited to matters with respect to
giving preference in the Community Offering to natural persons and trusts of
natural persons who are permanent residents of Alamance County, North Carolina.
Any and all interpretations, applications and determinations made by the Board
of Directors in good faith and on the basis of such information and assistance
as was then reasonably available for such purpose shall be conclusive and
binding upon us and our members and subscribers in the Subscription and
Community Offerings, subject to the authority of the FDIC and the Administrator.

     The Plan provides that, if deemed necessary or desirable by the Board of
Directors, the Plan may be substantively amended by a two-thirds vote of the
Board of Directors at any time prior to submission of the Plan and proxy
materials to our members. After submission of the Plan and proxy materials to
the members, the Plan may be amended by a two-thirds vote of the Board of
Directors at any time prior to the Special Meeting and at any time following the
Special Meeting with the concurrence of the FDIC and the Administrator. In its
discretion, the Board of Directors may modify or terminate the Plan upon the
order of the regulatory authorities without a resolicitation of proxies or
another Special Meeting. However, any modification of the Plan resulting in a
material change in the terms of the Conversion would require a resolicitation of
proxies and another meeting of members.

                                       33
<PAGE>
 
     The Plan further provides that in the event that mandatory new regulations
pertaining to conversions are adopted by the FDIC, the Administrator, the
Commission, the Federal Reserve Board or any successor agency prior to
completion of the Conversion, the Plan will be amended to conform to such
regulations without a resolicitation of proxies or another Special Meeting. In
the event that such new conversion regulations contain optional provisions, the
Plan may be amended to utilize such optional provisions at the discretion of the
Board of Directors without a resolicitation of proxies or another Special
Meeting. By adoption of the Plan, our members will be deemed to have authorized
amendment of the Plan under the circumstances described above.

CONDITIONS AND TERMINATION

     Completion of the Conversion requires the approval of the Plan by the
affirmative vote of not less than a majority of the total outstanding votes of
our members and the sale of all shares of the common stock within 12 months
following approval of the Plan by the members. Such time period may be extended
an additional 12 months by an amendment to the Plan. If these conditions are not
satisfied, the Plan will be terminated, and we will continue our business in the
mutual form of organization. The Board of Directors may terminate the Plan at
any time prior to the Special Meeting and, with the approval of the FDIC and the
Administrator, at any time after the Special Meeting.


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

GENERAL

     1st State Bancorp, Inc. has only recently been formed and, accordingly,
has no results of operations at this time. As a result, this discussion relates
to the financial condition and results of operations of the Bank.

     Our business consists principally of attracting deposits from the general
public and investing these funds in loans secured by single-family residential
and commercial real estate, secured and unsecured commercial loans and consumer
loans. Our profitability depends primarily on our net interest income which is
the difference between the income we receive on our loan and investment
securities portfolios and our cost of funds, which consists of interest paid on
deposits and borrowed funds. Net interest income also is affected by the
relative amounts of interest-earning assets and interest-bearing liabilities.
When interest-earning assets approximate or exceed interest bearing liabilities,
any positive interest rate spread will generate net interest income. Our
profitability also is affected by the level of other income and operating
expenses. Other income consists of miscellaneous fees related to our loans and
deposits, mortgage banking income and commissions from sales of annuities and
mutual funds. Operating expenses consist of compensation and benefits, occupancy
related expenses, federal deposit insurance premiums, data processing,
advertising and other expenses.

     Our operations are influenced significantly by local economic conditions
and by policies of financial institution regulatory authorities. Our cost of
funds is influenced by interest rates on competing investments and by rates
offered on similar investments by competing financial institutions in our market
area, as well as general market interest rates. Lending activities are affected
by the demand for financing of real estate and other types of loans, which in
turn is affected by the interest rates at which such financing may be offered.

     Our business emphasis has been to operate as a well-capitalized, profitable
and independent community-oriented financial institution dedicated to providing
quality customer service. We are committed to meeting the financial needs of the
communities in which we operate. We believe that we can be more effective in
servicing our customers than many of our nonlocal competitors because of our
ability to quickly and effectively provide senior management responses to
customer needs and inquiries. Our ability to provide these services is enhanced
by the stability of our senior management team.

                                       34
<PAGE>
 
     Beginning in the late 1980's, we have sought to gradually increase the
percentage of our assets invested in commercial real estate loans, commercial
loans and consumer loans, which have higher interest rates and shorter terms and
adjust more frequently to changes in interest rates than single-family
residential mortgage loans. At September 30, 1998, commercial real estate,
commercial and consumer loans totaled $38.8 million, $25.2 million and $6.3
million, respectively, which represented 18.8%, 12.2% and 3.1%, respectively, of
gross loans. At September 30, 1998, $100.9 million, or 48.8% of gross loans,
consisted of residential real estate mortgage loans. Following the Conversion,
we intend to continue to follow our current strategy of seeking growth
opportunities through increasing our portfolio of commercial real estate,
commercial and consumer loans while continuing to pursue single-family
residential mortgage loan origination activities.

YEAR 2000 COMPLIANCE

     Our operations, like those of most financial institutions, are
substantially dependent upon computer systems for our lending and deposit
activities. We are addressing the potential problems associated with the
possibility that the computers which control our data processing activities,
facilities and networks may not be programmed to read four-digit dates and, upon
the arrival of the year 2000, may recognize the two-digit code "00" as the year
1900 rather than 2000. This could cause systems to fail to function or generate
erroneous information.

     We formed a Year 2000 Committee early in 1998 with senior representatives
from every functional area of our Bank. At the direction of the Board, this
Committee is leading our efforts to ensure that we are ready for the Year 2000.
Our Board of Directors has approved the Bank's five phase Year 2000 Plan that
was developed in accordance with the guidelines set forth by the Federal
Financial Institutions Examination Council.

     The first phase, awareness, was intended to provide on-going information
to our employees, directors and customers of the impact of the Year 2000 issue.
We have conducted Year 2000 training for all directors and employees.

     The second phase, assessment, required us to review all systems that we
believe to be potential risks in order to minimize any Year 2000 operating
difficulties. This review included all major computer and non-computer based
systems, such as vaults, security systems and telephone systems. In April 1998,
we converted to a new computer system for processing all loan, deposit and
general ledger transactions. In conjunction with this conversion, we purchased
and installed new hardware and software throughout the Bank. The hardware and
software purchased are Year 2000 compliant or will be with minor modifications
or upgrades. The combined cost of this hardware and software was $1.2 million,
which was capitalized during the year ended September 30, 1998 in accordance
with our capitalization policy. This phase is virtually complete, and we are
following up on any remaining issues to complete our thorough assessment.

     The third phase, renovation and/or replacement, includes obtaining vendor
certification and/or the necessary upgrades and enhancements to ensure that our
existing systems are Year 2000 compliant. We are continuing to follow up with
third party vendors as necessary. At this time we have plans in place for all
mission critical systems to be compliant by December 31, 1998.

     The fourth phase, testing, is currently underway. The hardware has been
successfully tested, and we have begun testing the software. We have received
representations from our mission critical third party vendors that they are Year
2000 compliant. All testing is expected to be completed by January 31, 1999 and
any problems would be remedied by March 31, 1999.

     The last phase, implementation, will commence in the second quarter of
1999, ending with the first quarter of 2000. We are currently in the process of
developing contingency plans for processes that are not Year 2000 compliant. We
expect this contingency plan to be ready by March 31, 1999.

     We estimate that the total future cost of Year 2000 compliance, excluding
internal staffing costs, will not exceed $15,000. This estimate includes the
cost of an independent consultant that has been retained to assist us in

                                       35
<PAGE>
 
evaluating our Year 2000 Plan and assist us in testing. We believe that our
policies, plans and actions are in compliance with regulatory guidelines and
milestone dates.

     Our customers may also experience Year 2000 problems, which could
adversely affect their ability to comply with their obligations to us. We have
assessed all significant commercial loan customers to determine their Year 2000
readiness. Although Year 2000 readiness varies among our customers, we do not
expect that Year 2000 problems will have such a serious impact on our customers
as to cause them to suffer material adverse financial consequences.

     We believe that the potential effects on our internal operations from
Year 2000 issues can and will be addressed prior to the Year 2000. However, as
unforeseen circumstances arise, the Year 2000 issue could disrupt our normal
business operations. The most reasonably likely worst case Year 2000 scenarios
foreseeable at this time would include our not being able to systematically
process, in some combination, various types of customer transactions. This could
affect our ability to accept deposits or process withdrawals, originate new
loans or accept loan payments in the automated manner we currently utilize.
Depending upon how long this scenario lasted, this could have a material adverse
effect on our operations. Our contingency plan will address alternative methods
to enable us to continue to offer basic services to our customers. The costs of
our Year 2000 project and our benchmark dates are based on our best estimates,
which are based on a number of assumptions including future events. We cannot
guarantee that these estimates will be achieved at the cost disclosed or within
the time frames indicated.

LIQUIDITY AND CAPITAL RESOURCES

     Following the completion of the Stock Conversion, the Company initially
will have no business other than that of the Converted Bank and investing the
net Stock Conversion proceeds retained by it. Management believes that the net
proceeds to be retained by the Company, earnings on such proceeds and principal
and interest payments on the ESOP loan, together with dividends that may be paid
from the Converted Bank to the Company following the Stock Conversion, will
provide sufficient funds for its initial operations and liquidity needs;
however, no assurance can be given that the Company will not have a need for
additional funds in the future. The Converted Bank will be subject to certain
regulatory limitations with respect to the payment of dividends to the Company.
See "Dividend Policy" and "Regulation --Depository Institution Regulation --
Dividend Restrictions." The Company intends to lend a portion of the net
proceeds retained from the Stock Conversion to the ESOP to fund the ESOP's
purchase of common stock in the Stock Conversion. See "Use of Proceeds."

     At September 30, 1998, we had net worth of $26.0 million compared to
$23.3 million at September 30, 1997. We reported net income for the year ended
September 30, 1998 of $2.5 million, as compared to $2.5 million and $1.6 million
for the years ended September 30, 1997 and 1996, respectively. At September 30,
1998 and 1997, we had a capital to total assets ratio of 14.5% and 14.1%,
respectively. At September 30, 1998, we had Tier 1 leverage capital, Tier 1 
risk-based capital, and total risk-based capital of $25.9 million, $25.9 million
and $28.1 million, respectively.

     At September 30, 1998, we exceeded all regulatory minimum capital
requirements. For a detailed discussion of the Administrator's and FDIC's
regulatory capital requirements, and for a tabular presentation of our
compliance with such requirements, see "Regulation -- Depository Institution
Regulation -- Capital Requirements."

     For additional information regarding our actual, pro forma and minimum
required capital ratios at September 30, 1998, see "Historical and Pro Forma
Regulatory Capital Compliance." The Converted Bank will, as a result of the
Stock Conversion, have substantially increased capital. There can be no
assurance, however, that the Company's sources of funds will be sufficient to
satisfy the liquidity needs of the Company in the future.

     Our primary sources of funds are deposits, principal and interest
payments on loans, proceeds from the sale of loans, and to a lesser extent,
advances from the FHLB of Atlanta. While maturities and scheduled amortization
of loans are predictable sources of funds, deposit flows and mortgage
prepayments are greatly influenced by general interest rates, economic
conditions and local competition.

                                       36
<PAGE>
 
     Our primary investing activities have been the origination of loans and
the purchase of investment securities. During the years ended September 30,
1998, 1997 and 1996, we had $105.4 million, $79.2 million and $62.9 million,
respectively, of loan originations. During the years ended September 30, 1998,
1997 and 1996, we purchased investment securities in the amounts of $34.6
million, $7.0 million and $16.4 million, respectively. Our primary financing
activities are the attraction of savings deposits and, during the year ended
September 30, 1998, obtaining FHLB advances.

     The Administrator's regulations require savings banks to maintain liquid
assets equal to at least 10% of total assets. The computation of liquidity under
the Administrator's Regulations allows the inclusion of investments with readily
marketable value, including investments with maturities in excess of five years.
Our average liquidity ratios were 20.6%, 18.3%, and 19.4% for the years ended
September 30, 1998, 1997, and 1996, respectively. We have maintained high
liquidity ratios in recent years in anticipation of our conversion to a
commercial bank. Commercial banks generally are subject to higher liquidity
requirements than savings banks. Our most liquid assets are cash and cash
equivalents. The levels of these assets are dependent on our operating,
financing, lending and investing activities during any given period. At
September 30, 1998 and 1997, cash and cash equivalents totaled $31.1 million and
$15.0 million, respectively. We have other sources of liquidity should we need
additional funds. During the years ended September 30, 1998, 1997 and 1996, we
sold loans totaling $27.6 million, $9.2 million and $9.2 million, respectively.
Additional sources of funds include FHLB of Atlanta advances. During the year
ended September 30, 1998, we obtained $20.0 million of FHLB of Atlanta advances
with maturities matched to the repricing of a comparable amount of loans to
reduce our exposure to potentially rising interest rates. See " --
Asset/Liability Management." At September 30, 1998, we had $20.0 million of FHLB
of Atlanta advances outstanding, compared to $1.0 million at September 30, 1997.
Other sources of liquidity include loans and investment securities designated as
available for sale, which totaled $7.5 million and $9.9 million, respectively,
at September 30, 1998.

     We anticipate that we will have sufficient funds available to meet our
current commitments. At September 30, 1998, we had $7.5 million in commitments
to originate new loans, $40.4 million in unfunded commitments to extend credit
under existing equity line and commercial lines of credit and $505,000 in
standby letters of credit. At September 30, 1998, certificates of deposit which
are scheduled to mature within one year totaled $116.5 million. We believe that
a significant portion of such deposits will remain with us. However, some of
these deposits may be used to buy stock in the Offering.

ASSET/LIABILITY MANAGEMENT

     Net interest income, the primary component of our net income, is derived
from the difference or "spread" between the yield on interest-earning assets and
the cost of interest-bearing liabilities. We strive to achieve consistent net
interest income and to reduce our exposure to changes in interest rates by
matching the terms to repricing of our interest-sensitive assets and
liabilities. The matching of our assets and liabilities may be analyzed by
examining the extent to which our assets and liabilities are interest rate
sensitive and by monitoring the expected effects of interest rate changes on our
net interest income. Factors beyond our control, such as market interest rates
and competition, may also have an impact on our interest income and interest
expense.

     In the absence of any other factors, the overall yield or return
associated with our earning assets generally will increase from existing levels
when interest rates rise over an extended period of time, and conversely
interest income will decrease when interest rates decrease. In general, interest
expense will increase when interest rates rise over an extended period of time,
and conversely interest expense will decrease when interest rates decrease.
Therefore, by controlling the increases and decreases in its interest income and
interest expense which are brought about by changes in market interest rates, we
can significantly influence our net interest income.

     Our President reports to our Board of Directors on a regular basis on
interest rate risk and trends, as well as liquidity and capital ratios and
requirements. The Board of Directors reviews the maturities of our assets and
liabilities and establishes policies and strategies designed to regulate our
flow of funds and to coordinate the sources, uses and

                                       37
<PAGE>
 
pricing of such funds. The first priority in structuring and pricing our assets
and liabilities is to maintain an acceptable interest rate spread while reducing
the net effects of changes in interest rates. Our management is responsible for
administering the policies and determinations of the Board of Directors with
respect to our asset and liability goals and strategies.

     Our principal strategy in managing our interest rate risk has been to
increase interest rate sensitive assets such as commercial loans and consumer
loans. At September 30, 1998, we had $25.2 million of commercial loans and $6.3
million of consumer loans, which amounted to 12.2% and 3.1%, respectively, of
our gross loan portfolio, as compared to $22.9 million of commercial loans and
$5.4 million of consumer loans, respectively, at September 30, 1997, which
amounted to 11.3% and 2.7%, respectively, of our gross loan portfolio at that
date. In addition, in managing our portfolio of investment securities in recent
periods we emphasized the purchase of short-term securities so as to reduce our
exposure to increases in interest rates. In addition, at September 30, 1998, we
had $7.5 million of loans held for sale, and, pursuant to SFAS No. 115,
"Accounting for Certain Investments in Debt and Equity Securities", we had
investment securities with an aggregate amortized cost of $9.7 million and an
aggregate fair value of $9.9 million as available for sale. We are holding these
loans and investment securities as available for sale so that they may be sold
if needed for liquidity or asset and liability management purposes.

     We also have shortened the average repricing period of our assets by
retaining in our portfolio single-family residential mortgage loans only in
cases where the loan carries an adjustable rate or the loan has an interest rate
that is sufficient to compensate us for the risk of maintaining long-term, 
fixed-rate loans in our portfolio. During the past two years, we have sold a
significant portion of our fixed-rate, single-family residential mortgage loans
with terms of 15 years or more we have originated, and at September 30, 1998,
most of our single-family residential mortgage loans classified as held to
maturity were originated at least two years previously when market interest
rates were higher. At September 30, 1998, we held approximately $32.1 million of
adjustable-rate residential mortgage loans, which represented approximately
15.5% of our gross loan portfolio. Depending on conditions existing at any given
time, as part of our interest rate risk management strategy, we may sell newly
originated fixed-rate residential mortgage loans with original maturities of 15
years or more in the secondary market.

     In addition, in early 1998, as market interest rates were falling and our
yields on newly originated fixed-rate loans were decreasing, we became
increasingly concerned that if interest rates were to increase significantly
from the low rates then prevailing our cost of funds could be expected to
increase while we would continue to earn the same low yield on our fixed-rate
loans. To reduce our interest rate risk, in February 1998, we obtained $20.0
million in fixed-rate FHLB of Atlanta advances. These advances were structured
with maturities estimated to coincide with the expected repricing of
approximately $20.0 million of our loans. Through this strategy, we were able to
establish a positive interest rate spread on the $20.0 million of assets and
FHLB of Atlanta advances. The FHLB of Atlanta advances may not be prepaid, and
since the time the advances were obtained interest rates have declined, with the
result that we have been and currently are earning a lesser interest rate spread
than we would otherwise be earning had we not obtained the advances. However,
the strategy of obtaining FHLB advances with maturities matched to a comparably
sized portfolio of interest-earning assets has helped us to significantly reduce
our interest rate risk in times of rising interest rates with respect to that
portion of our assets and liabilities.

INTEREST RATE SENSITIVITY ANALYSIS

     The matching of assets and liabilities may be analyzed  by examining the
extent to which such assets and liabilities reprice in response to changes in
interest rates. The interest rate gap is defined as the difference between the
amount of interest-earning assets maturing or repricing within a specific time
period and the amount of interest-bearing liabilities that will mature or
reprice within the same time period. At September 30, 1998 our cumulative
interest rate gap (which is the difference between the amount of interest-
earning assets and interest-bearing liabilities maturing or repricing within one
year) as a percentage of total assets was a negative 2.4%. A gap is considered
positive when the amount of interest rate sensitive assets exceeds the amount of
interest rate sensitive liabilities. Conversely, a gap is considered negative
when the interest rate sensitive liabilities exceed the interest rate sensitive
assets.

                                       38
<PAGE>
 
     The following table sets forth the amounts of interest-earning assets and
interest-bearing liabilities outstanding at September 30, 1998 which are
anticipated by the Bank based upon certain assumptions, to reprice or mature in
each of the future time periods shown.

<TABLE>
<CAPTION>
                                                                    More than    More than
                                              3 months    4 to 12   1 year to     3 years      Over
                                               or less    months     3 years    to 5 years   5 years    Total
                                               -------    ------     -------    ----------   -------    -----  
                                                                 (Dollars In thousands)
<S>                                           <C>        <C>        <C>         <C>          <C>       <C>
Interest-earning assets:
   Loans receivable (1).....................   $73,237   $ 31,977    $ 32,288      $37,193   $29,627   $204,322
   Investment securities (2)................        --      3,992       9,484        7,000    20,923     41,399
   Interest-bearing overnight deposits......    25,559         --          --           --        --     25,559
                                               -------   --------    --------      -------   -------   --------
 
        Total interest-earning assets.......    98,796     35,969      41,772       44,193    50,550    271,280
 
Interest-bearing liabilities:
   Transaction accounts.....................     7,013     12,724       9,950        2,966     5,665     38,318
   Passbook and statement...................     1,279      3,497       7,253        4,729    11,333     28,091
   Certificates of deposit..................    38,881     78,156      35,406        8,218        --    160,661
   FHLB advances............................        --         --          --           --    20,000     20,000
                                               -------   --------    --------      -------   -------   --------
        Total interest-bearing liabilities..    47,173     94,377      52,609       15,913    36,998    247,070
 
Interest sensitivity gap....................   $51,623   $(58,408)   $(10,837)     $28,280   $13,552   $ 24,210
                                               =======   ========    ========      =======   =======   ========
Cumulative interest sensitivity gap.........   $51,623   $ (6,785)   $(17,622)     $10,658   $24,210
                                               =======   ========    ========      =======   =======
Ratio of cumulative gap to total
   interest-earning assets..................      19.0%      (2.5)%      (6.5)%        3.9%      8.9%
                                               =======   ========    ========      =======   =======
Ratio of cumulative gap to total
   assets...................................      17.9%      (2.4)%      (6.1)%        3.7%      8.4%
                                               =======   ========    ========      =======   =======
Ratio of interest-earning assets to
   interest-bearing liabilities.............     209.4%      38.1%       79.4%       277.7%    136.6%
                                               =======   ========    ========      =======   =======
</TABLE>

____________
(1)  Includes nonaccrual loans and loans held for sale.
(2)  Includes FHLB of Atlanta stock.
 
MARKET RISK

     Market risk reflects the risk of economic loss resulting from adverse
changes in market prices and interest rates. The risk of loss can be reflected
in diminished current market values and/or reduced potential net interest income
in future periods.

     Our market risk arises primarily from interest rate risk inherent in our
lending and deposit-taking activities. We do not maintain a trading account for
any class of financial instrument nor do we engage in hedging activities or
purchase high-risk derivative instruments. Furthermore, we are not subject to
foreign currency exchange rate risk or commodity price risk. For additional
information regarding the sensitivity to interest rate risk of the Bank's
interest-earning assets and interest-bearing liabilities, see the table under
"Business of 1st State Bank -- Lending Activities -- Loan Maturity Schedule," 
" -- Investment Activities" and "-- Deposit Activity and Other Sources of
Funds."

     We measure our interest rate risk by computing estimated changes in net
interest income and the net portfolio value ("NPV") of cash flows from assets,
liabilities and off-balance sheet items in the event of a range of assumed
changes in market interest rates. These computations estimate the effect on our
net interest income and NPV of sudden and sustained 1% to 4% increases and
decreases in market interest rates. Our Board of Directors has adopted an
interest rate risk policy which establishes maximum decreases in our estimated
net interest income of 10%, 15%, 20% and 25% in the event of 1%, 2%, 3% and 4%
increases and decreases in the market interest rates, respectively. Limits have
also been established for changes in NPV of decreases of 10%, 15%, 25% and 50%
in the event of 1%, 2%, 3% 

                                       39
<PAGE>
 
and 4% increases in market interest rates, respectively, and decreases of 5%,
10%, 15% and 20% in the event of 1%, 2%, 3% and 4% decreases in market interest
rates, respectively. The following table presents the projected change in net
interest income and NPV for the various rate shock levels at September 30, 1998.

<TABLE>
<CAPTION>
                       Net Portfolio Value                  Net Interest Income
 Change        ---------------------------------      ---------------------------------
in Rates       $ Amount    $ Change    % Change       $ Amount    $ Change     % Change
--------       --------    --------    --------       --------    --------     --------
                                          (Dollars in thousands)                                   
<S>            <C>        <C>          <C>            <C>        <C>           <C>
+ 400  bp      28,281     $(5,254)     (15.67)%       $9,478     $ 1,012         11.95%
+ 300  bp      29,839      (3,696)     (11.02)         9,240         774          9.13
+ 200  bp      31,397      (2,138)      (6.37)         9,002         536          6.32
+ 100  bp      32,466      (1,069)      (3.19)         8,734         268          3.16
Static         33,535           0        0.00          8,466           0          0.00
- 100  bp      33,638         103        0.31          8,082        (384)        (4.54)
- 200  bp      33,742         207        0.62          7,697        (769)        (9.09)
- 300  bp      33,156        (379)      (1.13)         7,265      (1,201)       (14.19)
- 400  bp      32,571        (964)      (2.87)         6,832      (1,634)       (19.30)
</TABLE>

     The above table indicates that at September 30, 1998, in the event of
sudden and sustained increases in prevailing market interest rates, our
estimated net interest income would be expected to increase and our NPV would be
expected to decrease, and that in the event of sudden and sustained decreases in
prevailing market interest rates, our estimated net interest income and NPV
would be expected to decrease, except that our NPV would be expected to increase
in the event of a sudden and sustained decrease in interest rates of 100 or 200
basis points. Our Board of Directors reviews our net interest income and NPV
position quarterly, and, if estimated changes in net interest income and NPV are
not within the targets established by the Board, the Board may direct management
to adjust the asset and liability mix to bring interest rate risk within Board
approved targets. At September 30, 1998, our estimated changes in net interest
income and NPV were within the targets established by the Board of Directors.

     Computations of prospective effects of hypothetical interest rate
changes, such as the above computations, are based on numerous assumptions,
including relative levels of market interest rates, loan prepayments and deposit
decay, and should not be relied upon as indicative of actual results. Further,
the computations do not contemplate any actions we may undertake in response to
changes in interest rates.

     Certain shortcomings are inherent in the method of analysis presented in
the above tables. For example, although certain assets and liabilities may have
similar maturities or periods to repricing, they may react in differing degrees
to changes in market interest rates. The interest rates on certain types of
assets and liabilities may fluctuate in advance of changes in market interest
rates, while interest rates on other types may lag behind changes in market
rates. Additionally, certain assets, such as adjustable-rate loans, have
features which restrict changes in interest rates on a short-term basis and over
the life of the asset. In addition, the proportion of adjustable-rate loans in
our portfolio could decrease in future periods if market interest rates remain
at or decrease below current levels due to refinance activity. Further, in the
event of a change in interest rates, prepayment and early withdrawal levels
would likely deviate significantly from those assumed in the table. Also, the
ability of borrowers to repay their adjustable-rate debt may decrease in the
event of an interest rate increase.

ANALYSIS OF NET INTEREST INCOME

     Net interest income represents the difference between income derived from
interest-earning assets and the interest expense on interest-bearing
liabilities. Net interest income is affected by both (i) the difference between
the rates of interest earned on interest-earning assets and the rates paid on
interest-bearing liabilities ("interest rate spread") and (ii) the relative
volume of interest-earning assets and interest-bearing liabilities.

                                       40
<PAGE>
 
     The following table sets forth certain information relating to our
consolidated balance sheets at September 30, 1998 and our consolidated
statements of income for the years ended September 30, 1998, 1997, and 1996 and
reflects the average yield on assets and average cost of liabilities at the date
and for the periods indicated. Such yields and costs are derived by dividing
income or expense by the average balance of assets and liabilities,
respectively, for the periods shown. Average balances are derived from daily
balances.

<TABLE>
<CAPTION>
                                                                   Year Ended September 30,
                                 ---------------------------------------------------------------------------------------------
                                 At September 30 1998                1998                                  1997 
                                 --------------------     ----------------------------       ---------------------------------
                                                                               Average                                 Average 
                                            Yield/        Average              Yield/         Average                  Yield/ 
                                  Balance    Cost         Balance   Interest    Cost          Balance     Interest      Cost  
                                 ---------  -------       --------  --------  --------        --------    --------    --------
                                                                                (Dollars in thousands)
<S>............................. <C>        <C>           <C>       <C>       <C>             <C>         <C>         <C>
Assets:
  Loans receivable (1)..........  $204,322    8.28%       $199,203   $17,185     8.63%        $186,413     $16,167       8.67%
  Investment securities (2).....    41,399    6.26          35,938     2,320     6.46           39,101       2,557       6.54
  Interest-bearing
   overnight deposits...........    25,559    5.75          20,409     1,203     5.89            6,116         337       5.51
                                  --------                --------   -------                  --------     -------
    Total interest-earning
     assets.....................   271,280    7.74         255,550    20,708     8.10          231,630      19,061       8.23
                                                                     -------                               -------
Non-interest-earning assets.....    16,943                  17,499                              15,362
                                  --------                --------                            --------
    Total assets................  $288,223                $273,049                            $246,992
                                  ========                ========                            ========

Liabilities and net worth:
  Deposits......................  $227,070    4.57        $224,334    10,331     4.61         $215,494       9,743       4.52
  FHLB advances.................    20,000    5.39          13,559       740     5.46            1,000          56       5.60
                                  --------                --------   -------                  --------     -------
    Total interest-bearing
     liabilities................   247,070    4.63         237,893    11,071     4.65          216,494       9,799       4.53
                                              ----                   -------  -------                      -------    -------
Non-interest-bearing
 liabilities....................    15,187                  10,436                               8,026
                                  --------                --------                            --------
    Total liabilities...........   262,257                 248,329                             224,520
Net worth.......................    25,966                  24,720                              22,472
                                  --------                --------                            --------
    Total liabilities and
     net worth..................  $288,223                $273,049                            $246,992
                                  ========                ========                            ========

Net interest income.............                                     $ 9,637                               $ 9,262
                                                                     =======                               =======
Interest rate spread............              3.11%                              3.45%                                   3.70%
                                          ========                            =======                                 =======
Net interest margin (3).........                                                 3.77%                                   4.00%
                                                                              =======                                 =======
Ratio of average
 interest-earning assets
  to average interest-bearing
   liabilities..................            109.80%                            107.42%                                 106.99%
                                          ========                            =======                                 =======

<CAPTION> 
                                 --------------------------------
                                              1996
                                 --------------------------------
                                                         Average
                                 Average                  Yield/
                                 Balance     Interest      Cost
                                 --------    --------    --------
                                                      
<S>                              <C>         <C>         <C>
Assets:
  Loans receivable (1).......... $171,148     $14,620       8.54%
  Investment securities (2).....   37,854       2,402       6.35
  Interest-bearing
   overnight deposits...........    6,605         373       5.65
                                 --------     -------
    Total interest-earning
     assets.....................  215,607      17,395       8.07
                                              -------
Non-interest-earning assets.....   13,313
                                 --------
    Total assets................ $228,920
                                 ========

Liabilities and net worth:
  Deposits......................  202,776       9,450       4.66
  FHLB advances.................      156           3       1.92
                                 --------     -------
    Total interest-bearing
     liabilities................  202,932       9,453       4.66
                                              -------    -------
Non-interest-bearing
 liabilities....................    5,842
                                 --------
    Total liabilities...........  208,774
Net worth.......................   20,146
                                 --------
    Total liabilities and
     net worth.................. $228,920
                                 ========

Net interest income.............              $ 7,942
                                              =======
Interest rate spread............                            3.41%
                                                         =======
Net interest margin (3).........                            3.68%
                                                         =======
Ratio of average
 interest-earning assets
  to average interest-bearing
   liabilities..................                          106.25%
                                                          ======
</TABLE> 

--------------------
(1)  Includes nonaccrual loans and loans held for sale.
(2)  Includes FHLB of Atlanta stock.
(3)  Represents net interest income divided by the average balance of interest-
     earning assets.

                                       41
<PAGE>
 
RATE/VOLUME ANALYSIS

     The table below sets forth certain information regarding changes in our
interest income and interest expense for the periods indicated. For each
category of interest-earning asset and interest-bearing liability, information
is provided on changes attributable to: (i) changes in volume (changes in volume
multiplied by old rate); (ii) changes in rates (change in rate multiplied by old
volume); (iii) changes in rate-volume (changes in rate multiplied by the changes
in volume); and (iv) total change (the sum of the previous columns).

<TABLE>
<CAPTION>
                                                                 Year Ended September 30,
                                     --------------------------------------------------------------------------
                                       1998           vs.          1997      1997          vs.         1996
                                     ------------------------------------  ------------------------------------
                                              Increase (Decrease)                  Increase (Decrease)
                                                   Due to                               Due to
                                     ------------------------------------  ------------------------------------
                                                        Rate/                                  Rate/
                                     Volume    Rate    Volume     Total     Volume     Rate   Volume      Total
                                     -------  -------  -------    -----     ------     -----  -------     -----
                                                                        (In thousands)
<S>                                  <C>      <C>      <C>        <C>       <C>       <C>     <C>         <C>
Interest income:
  Loans receivable (1).............  $1,109    $ (85)   $  (6)    $1,018     $1,304   $ 223     $ 20      $1,547
  Investment securities (2)........    (207)     (33)       3       (237)        79      74        2         155
  Other interest-earning assets....     788       23       55        866        (28)     (9)       1         (36)
                                     ------    -----    -----     ------     ------   -----     ----      ------
    Total interest-earning assets..   1,690      (95)      52      1,647      1,355     288       23       1,666
                                     ------    -----    -----     ------     ------   -----     ----      ------
                                                                                                          
Interest expense:                                                                                         
  Deposits.........................     400      181        7        588        593    (282)     (18)        293
  FHLB advances....................     703       (1)     (18)       684         16       6       31          53
                                     ------    -----    -----     ------     ------   -----     ----      ------
     Total interest-bearing                                                                               
         liabilities...............   1,103      180      (11)     1,272        609    (276)      13         346
                                     ------    -----    -----     ------     ------   -----     ----      ------
Change in net interest income......  $  587    $(275)   $  63     $  375     $  746   $ 564     $ 10      $1,320
                                     ======    =====    =====     ======     ======   =====     ====      ======      
</TABLE> 

_______________
(1)    Includes nonaccrual loans and loans held for sale.
(2)    Includes FHLB of Atlanta stock.


COMPARISON OF FINANCIAL CONDITION OF SEPTEMBER 30, 1998 AND 1997

     Total assets increased by $29.7 million, or 11.5%, from $258.5 million at
September 30, 1997 to $288.2 million at September 30, 1998. A significant
portion of the increase in assets was attributable to an increase in cash and
cash equivalents, which increased by $16.1 million, or 107.3%, from $15.0
million at September 30, 1997 to $31.1 million at September 30, 1998. Cash and
cash equivalents consist of cash and interest-bearing deposits in other banks
and are our most liquid assets. We increased our liquidity at September 30, 1998
due to: (i) increased loan sales and prepayments of loans in connection with
refinancings as a result of declining interest rates during the year ended
September 30, 1998; (ii) our retention of cash from a $20.0 million FHLB of
Atlanta advance; and (iii) an increase in deposits while loans receivable
remained stable.

     As a result of historically low prevailing interest rates during the year
ended September 30, 1998, we have increased our mortgage banking activities by
classifying as held for sale substantially all newly originated long-term, 
fixed-rate single-family residential mortgage loans. As a result, our loans held
for sale increased from $684,000 at September 30, 1997 to $7.5 million at
September 30, 1998. In addition, our loans receivable, net decreased by
$340,000, or .2%, from $197.1 million at September 30, 1997 to $196.8 million at
September 30, 1998. While single-family residential mortgage loans decreased by
$7.5 million, or 6.9%, from $108.4 million at September 30, 1997 to $100.9
million at September 30, 1998, we were able to increase our portfolio

                                       42
<PAGE>
 
of construction loans by $6.0 million, or 47.6%, from $12.6 million at September
30, 1997 to $18.6 million at September 30, 1998. The increase in our portfolio
of construction loans reflects our success in obtaining several acquisition and
development loans and loans to builders to build unsold residences, as well as
to an increase in the average size of loans to individuals to build their
primary residences.

     Our investment securities held to maturity increased by $6.7 million, or
28.6%, from $23.5 million at September 30, 1997 to $30.2 million at September
30, 1998, as we used excess liquidity to purchase investment securities.

     During the year ended September 30, 1998, we funded our asset growth
partly with increased deposit accounts but primarily with FHLB of Atlanta
advances. In February 1998, we obtained $20.0 million in FHLB of Atlanta
advances. These advances were structured with maturities estimated to coincide
with the expected repricing of approximately $20.0 million of our loans. See "--
Asset/Liability Management." As a result, FHLB of Atlanta advances totaled $20.0
million at September 30, 1998, as compared to $1.0 million at September 30,
1997. Deposit accounts increased by $6.4 million, or 2.8%, from $229.3 million
at September 30, 1997 to $235.7 million at September 30, 1998. Of the increase,
$5.1 million was attributable to an increase in the transaction accounts, which
we have been promoting during the year. In addition, we have had some success in
cross-selling checking accounts and money market accounts to our commercial
borrowers.

COMPARISON OF OPERATING RESULTS FOR THE YEARS ENDED SEPTEMBER 30, 1998 AND 1997

     Net Income.  We had $2.5 million of net income for each of the years
ended September 30, 1998 and 1997. During the year ended September 30, 1998,
increases in net interest income and other income were offset by increases in
the provision for loan losses and operating expenses. We are establishing a
charitable foundation in connection with the Stock Conversion and contributing
up to 150,000 shares of common stock to the Foundation. The contribution to the
Foundation will reduce our earnings in 1999, the fiscal year in which the
Foundation is to be established and the contribution made, by up to $2.0
million. If the Foundation had been established and the contribution made during
the year ended September 30, 1998, we would have reported net income of
approximately $541,000 rather than reporting net income of approximately $2.5
million, for the year ended September 30, 1998.

     Net Interest Income.   Net interest income was $9.6 million for the year
ended September 30, 1998, as compared to $9.3 million for the year ended
September 30, 1997, representing an increase of $375,000, or 4.1%. During the
year ended September 30, 1998, we were able to increase our net interest income
by leveraging our capital and increasing our levels of interest-earning assets
and interest-bearing liabilities. The average balance of interest-earning assets
increased by $23.9 million, or 10.3%, from $231.6 million for the year ended
September 30, 1997 to $255.6 million for the year ended September 30, 1998
primarily due to increases in the average balances of loans receivable and
interest-bearing overnight deposits. In addition, the average balance of
interest-bearing liabilities increased by $21.4 million, or 9.9%, from $216.5
million for the year ended September 30, 1997 to $237.9 million for the year
ended September 30, 1998 primarily due to increases in the average balances of
deposits and FHLB advances. The effect of the increases in the average balances
of assets and liabilities was offset in part by a decrease in our interest rate
spread from 3.70% for the year ended September 30, 1997 to 3.45% for year ended
September 30, 1998. In February 1998, we obtained $20.0 million in fixed-rate
FHLB of Atlanta advances. These advances were structured with maturities
estimated to coincide with the expected repricing of approximately $20.0 million
of our loans. Through this strategy, we were able to establish a positive
interest rate spread on the $20.0 million of assets and FHLB of Atlanta
advances. The proceeds of advances increased our cash and cash equivalents
pending deployment of the proceeds into loans. Since the time the advances were
obtained interest rates have declined, with the result that our cost of funds
has been negatively affected because the advances have a higher rate of interest
than other sources of funds while cash and cash equivalents have a lower yield
than our other interest-earning assets. As a result, we have been, and currently
are, earning a lesser interest rate spread than we would otherwise be earning
had we not obtained the advances. However, the strategy of obtaining FHLB
advances with maturities matched to a comparably sized portfolio of interest-
earning assets has helped us to significantly reduce our interest rate risk in
times of rising interest rates with respect to that

                                       43
<PAGE>
 
portion of our assets and liabilities. See "--Asset/Liability Management."
However, during the year ended September 30, 1998, we continued our efforts to
increase the yield on interest-earning assets by increasing originations of
loans that are based on the prime rate, such as commercial loans and home equity
lines of credit, and to lower our cost of funds by successfully attracting lower
cost deposits such as checking accounts and money market accounts.

     Interest Income.  Total interest income was $20.7 million for the year
ended September 30, 1998, as compared to $19.1 million for the year ended
September 30, 1997, representing an increase of $1.6 million, or 8.6%. Such
increase was due primarily to a $23.9 million, or 10.3%, increase in the average
balance of the interest-earning assets during such year and, offset in part by a
13 basis point decrease in the average yield on interest-earning assets.

     Interest on loans receivable increased by $1.0 million, or 6.3%, from
$16.2 million for the year ended September 30, 1997 to $17.2 million of the year
ended September 30, 1998. The increase was due primarily to an increase of $12.8
million, or 6.9%, in the average balance of loans receivable from $186.4 million
for the year ended September 30, 1997 to $199.2 million for the year ended
September 30, 1998, reflecting increased single-family residential mortgage loan
and commercial loan originations. The increase in the average balance of loans
receivable more than offset a 4 basis point decrease in the average yield on
loans receivable due to falling market interest rates during the year ended
September 30, 1998. Offsetting the decreased yield attributable to declining
market interest rates were our increased originations of commercial loans and
construction loans, which carry interest rates based on the prime rate, enabling
us earn a higher yield on interest-earning assets, as commercial loans generally
earn higher interest rates than single-family residential mortgage loans,
although those loans entail greater credit risk. See "Business of 1st State 
Bank --Lending Activities --Commercial Lending."

     Interest on investment securities decreased by $237,000, or 9.3%, from
$2.6 million for the year ended September 30, 1997 to $2.3 million for the year
ended September 30, 1998. The decrease was attributable to a $3.2 million, or
8.1%, decrease in the average balance of investment securities from $39.1
million for the year ended September 30, 1997 to $35.9 million for the year
ended September 30, 1998, combined with an 8 basis point decrease in the average
yield on investment securities. As market interest rates fell during the year
ended September 30, 1998, a higher than normal level of our investment
securities were called by the issuers.

     Interest on interest-bearing overnight deposits increased by $867,000
from $336,000 for the year ended September 30, 1997 to $1.2 million for the year
ended September 30, 1998. The increase was due primarily to a $14.3 million
increase in the average balance of other interest-earning assets from $6.1
million for the year ended September 30, 1997 to $20.4 million for the year
ended September 30, 1998, as a result of the $20.0 million of FHLB of Atlanta
advances obtained in February 1998, as well as to a 38 basis point increase in
the yield on other interest-earning assets.

     Interest Expense. During the years ended September 30, 1997 and 1998,
interest expense consisted primarily of interest on deposit accounts. Interest
on deposit accounts increased by $588,000, or 6.0%, from $9.7 million for the
year ended September 30, 1997 to $10.3 million for the year ended September 30,
1998. The increase was due to an $8.8 million, or 4.1%, increase in the average
balance of deposits from $215.5 million for the year ended September 30, 1997 to
$224.3 million for the year ended September 30, 1998. In addition, there was a 9
basis point increase in the average cost of deposits. The increase in the
average cost of deposits reflected our decision to increase our deposit rates to
match competition in our market. In addition, during the year ended September
30, 1998, we had interest expense of $740,000 on our increased balance of FHLB
of Atlanta advances, as compared to $56,000 of interest expense during the year
ended September 30, 1997.

     Provisions for Loan Losses.  Provisions for loan losses are charged to
earnings to maintain the total allowance for loan losses at a level considered
adequate by management to provide for probable loan losses, based on prior loss
experience, volume and type of lending we conduct, industry standards and past
due loans in our loan portfolio. Our policies require the review of assets on a
regular basis, and we appropriately classify loans as well as other assets if
warranted. See "Business of 1st State Bank -- Lending Activities --
Nonperforming Loans and Other Problem Assets" and " -- Allowance for Loan
Losses." We believe we use the best information available to make a
determination with

                                       44
<PAGE>
 
respect to the allowance for loan losses, recognizing that future adjustments
may be necessary depending upon a change in economic conditions. We provided
$477,000 and $261,000 for loan losses during the years ended September 1998 and
1997, respectively. The allowance for loan losses was $3.2 million at September
30, 1998, as compared to $2.8 million at September 30, 1997. The ratio for the
allowance for loan losses to total loans, net of loans in process and deferred
loan fees was 1.61% and 1.38% at September 30, 1998 and 1997, respectively. The
increased provision during the year ended September 30, 1998 reflects the
increased risk in our loan portfolio attributable to the higher percentage of
loans invested in commercial loans, commercial real estate loans and
construction loans. At September 30, 1998, commercial loans, commercial real
estate loans and construction loans totaled $25.2 million, $38.8 million and
$18.6 million, respectively, which amounted to 12.2%, 18.8% and 9.0%,
respectively, of the gross loan portfolio. Comparatively, at September 30, 1997,
commercial loans, commercial real estate loans and construction loans totaled
$22.9 million, $34.3 million and $12.6 million, respectively, which amounted to
11.3%, 17.0% and 6.2%, respectively, of the gross loan portfolio. Single-family
residential real estate loans totaled $100.9 million and $108.4 million at
September 30, 1998 and 1997, respectively, which represented 48.8% and 53.8%,
respectively, of the gross loan portfolio at such dates.

     In addition, changes in the economy during fiscal year 1998 have altered
 the credit risk profile of some of our customers and as a result, we increased
 our provision to reflect this additional credit risk.
 
     Other Income.  Total other income was $1.5 million for the years ended
September 30, 1998 and 1997. During the year ended September 30, 1998, mortgage
banking income, net increased by $256,000. As interest rates decreased during
the year, we decided to sell a greater volume of new residential mortgage loan
originations to reduce our exposure to interest rate risk, thereby generating
increased mortgage banking income. In addition, during the year ended September
30, 1998, commissions from sales of annuities and mutual funds increased by
$38,000 as customers shifted retirement funds into non-insured investments.
Also, customer service fees on loan and deposit accounts increased by $65,000,
or 13.1%, from $500,000 for the year ended September 30, 1997 to $566,000 for
the year ended September 30, 1998 as a result of increased levels of deposit and
loan accounts. Offsetting these increases was a $269,000 securities loss during
the year ended September 30, 1998 from an other than temporary decline in the
value of marketable equity securities. During the mid 1980s, we made an
investment in a mutual fund which invests in mortgage-backed securities and U.S.
Government and agency securities. This investment is classified as available for
sale, and in prior years we have reflected a net unrealized loss on investment
securities on our consolidated balance sheets attributable to the then current
unrealized loss associated with this mutual fund investment. During the year
ended September 30, 1998, we determined that the value of the investment in
marketable equity securities would not recover in the foreseeable future and we
recognized an expense attributable to the other than temporary decline in fair
value. The fair value of marketable equity securities depends largely on changes
in interest rates as the underlying securities are debt securities. To the
extent that there are future changes in interest rates there could be additional
declines in value that are other than temporary.

     Operating Expenses.  Total operating expenses increased by $302,000, or
4.7%, from $6.5 million for the year ended September 30, 1997 to $6.8 million
for the year ended September 30, 1998. Compensation and related benefits
increased by $267,000, or 6.2%, from $4.3 million for the year ended September
30, 1997 to $4.6 million for the year ended September 30, 1998, due to an
increase in expense attributable to normal salary increases and increases in the
number of employees. During the year ended September 30, 1998 and 1997, we
incurred $987,000 and $1.1 million, respectively, in compensation and related
expenses attributable to the implementation and vesting of a Deferred
Compensation Plan for directors and executive officers. The expense associated
with that plan is expected to approximate $200,000 annually beginning with the
year ended September 30, 1999. Occupancy and equipment expenses increased by
$105,000, or 11.1%, from $940,000 for the year ended September 30, 1997 to $1.0
million for the year ended September 30, 1998 due to an $85,000 write-down of
obsolete equipment. Deposit insurance premiums increased by $38,000, or 36.9%,
from $104,000 for the year ended September 30, 1997 to $142,000 for the year
ended September 30, 1998 due to increased levels of deposits. Our operating
expenses will increase in the future due to added expense associated with our
employee stock ownership plan and, later on, our restricted stock plan, as well
as with the costs of being a public company.

                                       45
<PAGE>
 
     Income Taxes.  Our income tax expense was $1.4 million for each of the
years ended September 30, 1998 and 1997.  Our effective tax rate was 35.1% for
the year ended September 30, 1998 and 36.2% for the year ended September 30,
1997.

COMPARISON OF OPERATING RESULTS FOR THE YEARS ENDED SEPTEMBER 30, 1997 AND 1996

     Net Income.  We had $2.5 million of net income for the year ended
September 30, 1997, compared to $1.6 million of net income for the year ended
September 30, 1996, representing an increase of $952,000, or 59.7%. The
principal reason for the increase was a $1.3 million increase in net interest
income.

     Net Interest Income.   Net interest income was $9.3 million for the year
ended September 30, 1997, as compared to $7.9 million for the year ended
September 30, 1996, representing an increase of $1.3 million, or 16.6%. The
increase was due to an increase in our interest rate spread from 3.41% for the
year ended September 30, 1996 to 3.70% for year ended September 30, 1997. During
the year ended September 30, 1997, we were able to increase the yield on
interest-earning assets by increasing loans that are based on the prime rate,
such as commercial loans and home equity lines of credit. Concurrently, we were
able to lower our cost of funds by increasing lower cost deposits such as
checking accounts and money market accounts. During the year ended September 30,
1997, we were able to increase our net interest income by leveraging our capital
and increasing our levels of interest-earning assets and interest-bearing
liabilities. The average balance of interest-earning assets increased by $16.0
million, or 7.4%, from $215.6 million for the year ended September 30, 1996 to
$231.6 million for the year ended September 30, 1997 primarily due to increases
in the average balance of loans receivable. In addition, the average balance of
interest-bearing liabilities increased by $13.6 million, or 6.7%, from $202.9
million for the year ended September 30, 1996 to $216.5 million for the year
ended September 30, 1997 primarily due to increases in the average balance of
deposits.

     Interest Income.  Total interest income was $19.1 million for the year
ended September 30, 1997, as compared to $17.4 million for the year ended
September 30, 1996, representing an increase of $1.7 million, or 9.6%. Such
increase was due primarily to a $16.0 million, or 7.4%, increase in the average
balance of the interest-earning assets during such year and, to a lesser extent,
to a 16 basis point increase in the average yield on interest-earning assets.

     Interest on loans receivable increased by $1.5 million, or 10.6%, from
$14.6 million for the year ended September 30, 1996 to $16.2 million of the year
ended September 30, 1997. The increase was due primarily to an increase of $15.3
million, or 8.9%, in the average balance of loans receivable from $171.1 million
for the year ended September 30, 1996 to $186.4 million for the year ended
September 30, 1997, reflecting increased single-family residential mortgage loan
and commercial loan originations. The increase in interest on loans receivable
also reflected a 13 basis point increase in the average yield on loans
receivable. By increasing originations of commercial loans and home equity lines
of credit that carry interest rates based on the prime rate, we were able to
increase our average yield on interest-earning assets, as commercial loans
generally earn higher interest rates than single-family residential mortgage
loans, although those loans entail greater credit risk. See "Business of 1st
State Bank -- Lending Activities -- Commercial Lending."

     Interest on investment securities increased by $156,000, or 6.5%, from
$2.4 million for the year ended September 30, 1996 to $2.6 million for the year
ended September 30, 1997. The increase was attributable to a $1.2 million, or
3.3%, increase in the average balance of investment securities from $37.9
million for the year ended September 30, 1996 to $39.1 million for the year
ended September 30, 1997, as well as to a 19 basis point increase in the average
yield on investment securities. As market interest rates were rising during the
year ended September 30, 1997, we invested excess liquidity in short-term U.S.
government and agency securities to increase our yield on interest-earning
assets.

     Interest Expense. During the years ended September 30, 1996 and 1997,
interest expense consisted almost entirely of interest on deposit accounts.
Interest on deposit accounts increased by $293,000, or 3.1%, from $9.5 million
for the year ended September 30, 1996 to $9.7 million for the year ended
September 30, 1997. The increase was due

                                       46
<PAGE>
 
to a $12.7 million, or 6.3%, increase in the average balance of deposits from
$202.8 million for the year ended September 30, 1996 to $215.5 million for the
year ended September 30, 1997. The increase in the average balance of deposits
more than offset a 14 basis point decrease in the average cost of deposits. The
decrease in the average cost of deposits reflected the increase in the
percentage of our deposits comprised of lower cost deposits such as checking
accounts and money market accounts.

       Provisions for Loan Losses. We provided $261,000 and $281,000 for loan
losses during the years ended September 1997 and 1996, respectively. The
allowance for loan losses was $2.8 million at September 30, 1997, as compared to
$2.5 million at September 30, 1996. The ratio for the allowance for loan losses
to total loans, net of loans in process and deferred loan fees was 1.38% at
September 30, 1997 and 1.42% at September 30, 1996.
 
       Other Income. Total other income increased by $289,000 , or 24.5%, from
$1.2 million for the year ended September 30, 1996 to $1.5 million for the year
ended September 30, 1997. Of such increase, $113,000 was attributable to
increased commissions from sales of annuities and mutual funds, as customers
shifted retirement funds into noninsured investments, and $77,000 was
attributable to an increase in mortgage banking income, net. Also contributing
to the increase in other income was a $88,000, or 21.4%, increase in customer
service fees on loan and deposit accounts, which increased from $412,000 for the
year ended September 30, 1996 to $500,000 for the year ended September 30, 1997
as a result of increased levels of loan and deposit accounts.

       Operating Expenses. Total operating expenses increased by $69,000, or
1.1%, from $6.4 million for the year ended September 30, 1996 to $6.5 million
for the year ended September 30, 1997. Compensation and related benefits
increased by $1.4 million, or 47.3%, from $2.9 million for the year ended
September 30, 1996 to $4.3 million for the year ended September 30, 1997, due to
an increase in expense attributable to the implementation and vesting of a
Deferred Compensation Plan for directors and executive officers. The increase in
compensation and related benefits offset a decrease in operating expenses as a
result of a $1.3 million expense incurred during the year ended September 30,
1996 as a result of a special assessment by the FDIC to recapitalize the SAIF.
During the year ended September 30, 1996, we paid a one-time special assessment
in the amount of $1.3 million assessed by the FDIC on all SAIF-insured
institutions to capitalize the SAIF insurance fund of the FDIC up to required
reserved ratio. Prior to such special assessment, we paid continuing SAIF
insurance premiums at the rate of 23 cents per $100 of SAIF deposits. However,
the rate dropped to 6.4 cents per $100 effective January 1, 1997 through
September 30, 1999 and, based on our current condition, will further decrease to
2.4 cents per $100 thereafter. This revised deposit insurance rate structure
enabled us to recognize the substantial reduction in deposit insurance premiums
during the year ended September 30, 1997. Deposit insurance premiums decreased
from $465,000 for the year ended September 30, 1996 to $104,000 for the year
ended September 30, 1997.

       Income Taxes. Our income tax expense was $841,000 and $1.4 million for
the years ended September 30, 1996 and 1997, respectively. Our effective tax
rate was 34.5% for the year ended September 30, 1996 and 36.2% for the year
ended September 30, 1997.

IMPACT OF INFLATION AND CHANGING PRICES

       Our financial statements and the accompanying notes presented elsewhere
in this document, have been prepared in accordance with generally accepted
accounting principles, which require the measurement of financial position and
operating results in terms of historical dollars without considering the change
in the relative purchasing power of money over time and due to inflation. The
impact of inflation is reflected in the increased cost of our operations. As a
result, interest rates have a greater impact on our performance than do the
effects of general levels of inflation. Interest rates do not necessarily move
in the same direction or to the same extent as the prices of goods and services.

                                       47
<PAGE>
 
IMPACT OF NEW ACCOUNTING STANDARDS

       Reporting Comprehensive Income. In June 1997, the FASB issued Statement
of Financial Accounting Standards No. 130 ("SFAS 130"), "Reporting Comprehensive
Income." SFAS 130 establishes standards for reporting and displaying
comprehensive income and its components (revenues, expenses, gains, and losses)
in a full set of general-purpose financial statements. This Statement requires
that an enterprise (a) classify items of other comprehensive income by their
nature in the financial statement and (b) display the accumulated balance of
other comprehensive income separately from retained earnings and additional 
paid-in-capital in the equity section of a statement of financial position. SFAS
130 is effective for fiscal years beginning after December 15, 1997.
Reclassification of financial statements for earlier periods provided for
comparative purposes is required. We adopted SFAS 130 on October 1, 1998. Other
comprehensive income consists of unrealized gains and losses on certain
investment securities and would have been $167,000 at September 30, 1998. Total
comprehensive income would have been $2.7 million at September 30, 1998.

       Disclosures Regarding Segments. In June 1997, the FASB issued Statement
of Financial Accounting Standards No. 131 ("SFAS 131"), "Disclosures about
Segments of an Enterprise and Related Information." SFAS 131 establishes
standards for the way that public businesses report information about operating
segments in annual financial statements and requires that those enterprises
report selected information about operating segments in interim financial
reports issued to shareholders. It also establishes standards for related
disclosures about products and services, geographic areas, and major customers.
This Statement is effective for financial statements for periods beginning after
December 15, 1997 and in the initial year of application, comparative
information for earlier years is to be restated. We adopted SFAS 131 on October
1, 1998 without any significant impact on our consolidated financial statements
as we operate as one segment.

       Employers Disclosures About Pensions and Other Postretirement Benefits.
In February 1998, the FASB issued SFAS No. 132, "Employers Disclosures About
Pension and Other Postretirement Benefits," which standardizes disclosure
requirements for pensions and postretirement benefits. This Statement is
effective for fiscal years beginning after December 15, 1997. We do not believe
that the adoption of SFAS No. 132 will have a material effect on our
consolidated financial statements because we do not have a pension plan or other
postretirement benefits.

       Accounting for Derivative Instruments and Hedging Activities. In June
1998, the FASB issued SFAS No. 133. This Statement standardizes the accounting
for derivative instruments including certain derivative instruments embedded in
other contracts, by requiring that an entity recognize these items as assets or
liabilities in the statement of financial position and measure them at fair
value. This Statement generally provides for matching the timing of gain or loss
recognition on the hedging instrument with the recognition of the changes in the
fair value of the hedged asset or liability that are attributable to the hedged
risk or the earnings effect of the hedged forecasted transaction. The Statement,
which is effective for all fiscal quarters of all fiscal years beginning after
June 15, 1999, will not affect our financial position or our results of
operations because we do not have or intend to have derivative financial
instruments.

                      BUSINESS OF 1ST STATE BANCORP, INC.

       We organized the Company in November 1998 for the purpose of becoming a
holding company to own all of the Bank's outstanding capital stock. The Company
currently is not an operating company. Following the Conversion, the Company
will be engaged primarily in the business of directing, planning and
coordinating the business activities of the Converted Bank. In the future, the
Company may become an operating company or acquire or organize other operating
subsidiaries, including other financial institutions, though we have no current
plans in this regard. Initially, the Company will not maintain offices separate
from those of the Bank nor employ any persons other than its officers who will
not be separately compensated for such service.

                                       48
<PAGE>
 
                           BUSINESS OF 1ST STATE BANK

GENERAL

       Our principal business consists of attracting deposits from the general
public and investing these funds in loans secured by single-family residential
and commercial real estate, secured and unsecured commercial loans and consumer
loans. We derive our income principally from interest earned on loans and
investments and, to a lesser extent, miscellaneous fees relating to our loans
and deposits, mortgage banking income and commissions from annuity and mutual
fund sales. Our principal expenses are interest expense on deposits and
borrowings and other expense such as compensation and related benefits,
occupancy and equipment expenses and other miscellaneous expenses. Funds for
these activities are provided principally by deposits, borrowings, repayments of
outstanding loans and investments and operating revenues.

MARKET AREA

       Our market area is Alamance County in north central North Carolina,
located on the Interstate 85 corridor between the Piedmont Triad and Research
Triangle. We estimate that more than 90% of deposits and loans come from our
market area.

       Historically, the economy of our market area has been heavily dependent
on the textile industry. During the past 20 years, the economy in Alamance
County has diversified to some extent, with increasing employment in the areas
of insurance, banking, manufacturing and services. Major employers in the area
include LabCorp, Burlington Industries, Alamance County Schools, Glenraven Mills
and Alamance Health Services. Nevertheless, the economy in Alamance County
continues to be heavily dependent on the textile industry.

                                       49
<PAGE>
 
LENDING ACTIVITIES

       Loan Portfolio Composition. At September 30, 1998, our gross loan
portfolio totaled $206.6 million and represented 71.7% of total assets. The
following table sets forth information relating to the composition of our loan
portfolio by type of loan at the dates indicated. At September 30, 1998, we had
no concentrations of loans exceeding 10% of gross loans other than as disclosed
below. Excluded from this table are mortgage loans held for sale which are
presented separately on our consolidated balance sheets and in "Selected
Consolidated Financial Information and Other Data."

<TABLE>
<CAPTION>
                                                                           AT SEPTEMBER 30,
                                                                     -------------------------
                                              1998                1997             1996               1995               1994
                                        -----------------     --------------   ---------------    -------------      --------------
                                        AMOUNT       %         AMOUNT    %      AMOUNT    %       AMOUNT     %        AMOUNT     % 
                                        ------      ---        ------   ---     ------   ---      ------    ---       ------    ---
                                                                        (DOLLARS IN THOUSANDS)
<S>                                    <C>        <C>        <C>       <C>     <C>       <C>     <C>       <C>     <C>       <C>
Real estate loans:
  Single-family residential........... $100,891    48.84%    $108,400   53.76% $100,247   55.70% $ 98,660   55.78% $ 91,094   57.51%
  Commercial..........................   38,763    18.76       34,333   17.02    35,302   19.62    35,774   20.23    29,922   18.89
  Home equity.........................   16,877     8.17       18,141    8.99    15,872    8.82    16,409    9.28    15,326    9.67
  Construction........................   18,572     8.99       12,582    6.24     7,838    4.36     7,084    4.01     5,675    3.58
                                       --------   ------     --------  ------  --------  ------  --------  ------  --------  ------ 
      Total real estate...............  175,103    84.76      173,456   86.01   159,259   88.50   157,927   89.30   142,017   89.65
  Commercial..........................   25,190    12.19       22,870   11.34    16,989    9.44    15,072    8.52    12,876    8.13
  Consumer............................    6,310     3.05        5,354    2.65     3,706    2.06     3,847    2.18     3,514    2.22
                                       --------   ------     --------  ------  --------  ------  --------  ------  -------- ------- 
                                        206,603   100.00%     201,680  100.00%  179,954  100.00%  176,846  100.00%  158,407  100.00%
                                       --------   ======     --------  ======  --------  ======   -------  ======  --------  ======
Less:
  Loans in process....................   (6,446)               (1,660)           (3,515)           (3,457)           (2,446)
  Deferred fees and discounts.........     (147)                 (144)              (94)              (73)                1
  Allowance for loan losses...........   (3,228)               (2,754)           (2,496)           (2,223)           (1,767)
                                       --------              --------          --------          --------          --------  
      Total........................... $196,782              $197,122          $173,849          $171,093          $154,195
                                       ========              ========          ========          ========          ========  
</TABLE>

                                       50
<PAGE>
 
LOAN MATURITY SCHEDULE

       The following table sets forth certain information at September 30, 1998
regarding the dollar amount of loans maturing in our portfolio based on their
contractual terms to maturity, including scheduled repayments of principal.
Demand loans, loans having no stated schedule of repayments, such as lines of
credit, and overdrafts are reported as due in one year or less. The table does
not include any estimate of prepayments which significantly shorten the average
life of mortgage loans and may cause our repayment experience to differ from
that shown below.

<TABLE>
<CAPTION>
                                                           DUE AFTER        DUE AFTER        DUE AFTER
                                                           3 THROUGH        5 THROUGH        10 THROUGH       DUE AFTER 15
                           DUE DURING THE YEAR ENDING     5 YEARS AFTER   10 YEARS AFTER    15 YEARS AFTER     YEARS AFTER
                                 SEPTEMBER 30,            SEPTEMBER 30,    SEPTEMBER 30,     SEPTEMBER 30,    SEPTEMBER 30,     
                           ---------------------------                            
                           1999      2000      2001           1998            1998              1998              1998       TOTAL 
                           ------   ------  ----------    ------------    --------------    ------------      ------------   ------
                                                                      (IN THOUSANDS)
<S>                        <C>       <C>       <C>        <C>             <C>               <C>               <C>           <C> 
Real estate loans:
  Single-family........... $ 3,140   $3,321    $ 1,530     $ 5,887        $12,368           $15,753           $58,892       $100,891
  Commercial..............   3,020    1,581      1,851      15,314          7,028             7,431             2,538         38,763
  Home equity.............     309       29         54         396          5,083            11,006                --         16,877
  Construction............   8,605    1,390      1,758         373             --                --                --         12,126
Commercial................  12,181    2,495      4,236       4,727            790               761                --         25,190
Consumer..................   2,024      690      1,347       2,056            193                --                --          6,310
                            -------  ------    -------     -------        -------           -------           --------      --------
     Total................ $29,279   $9,506    $10,776     $28,753        $25,462           $34,951           $61,430       $200,157
                           =======   ======    =======     =======        =======           =======           ========      ========

</TABLE> 
 
  The following table sets forth at September 30, 1998, the dollar amount of all
loans due one year or more after September 30, 1998 which have predetermined
interest rates and have floating or adjustable interest rates.

<TABLE>
<CAPTION>
                                                    PREDETERMINED         FLOATING OR
                                                       RATE            ADJUSTABLE RATES          TOTAL
                                                    -------------      ----------------          ------
                                                                       (IN THOUSANDS)
        <S>                                         <C>                <C>                   <C>
        Real estate loans:
           Single-family residential......          $   66,846         $    30,905           $    97,751
           Commercial.....................              22,485              13,258                35,743 
           Home equity....................               2,811              13,757                16,568 
           Construction...................                 569               2,952                 3,521 
        Commercial.....................                  4,199               8,810                13,009 
        Consumer.......................                  4,205                  81                 4,286  
                                                    ----------         -----------           -----------
              Total.......................          $  101,115         $    69,763           $   170,878
                                                    ==========         ===========           ===========
</TABLE>

                                       51
<PAGE>
 
       Scheduled contractual principal repayments of loans do not reflect the
actual life of the loans. The average life of loans can be substantially less
than their contractual terms because of prepayments. In addition, due-on-sale
clauses on loans generally give us the right to declare a loan immediately due
and payable in the event that, among other things, the borrower sells the real
property subject to the mortgage and the loan is not repaid. The average life of
mortgage loans tends to increase when current mortgage loan market rates are
substantially higher than rates on existing mortgage loans and, conversely,
decrease when current mortgage loan market rates are substantially lower than
rates on existing mortgage loans.

       Originations, Purchases and Sales of Loans. We generally have authority
to originate and purchase loans secured by real estate located throughout the
United States. Consistent with our emphasis on being a community-oriented
financial institution, we concentrate our lending activities in our market area.

       The following table sets forth certain information with respect to our
loan origination, purchase and sale activity for the periods indicated.

<TABLE>
<CAPTION>
                                             YEAR ENDED SEPTEMBER 30,       
                                     ---------------------------------------
                                       1998           1997            1996    
                                     --------       ---------       --------  
                                                (IN THOUSANDS) 30            
<S>                                  <C>           <C>              <C>       
  Loans originated:                                                           
    Real estate loans:                                                        
      Single-family residential..    $ 44,118      $ 27,731         $ 20,517  
      Commercial.................       9,437         5,446            9,536  
      Home equity................       7,351         6,340            5,083  
      Construction...............      19,158        17,082           12,912  
                                     --------       -------          -------  
       Total real estate loans...      80,064        56,599           48,048  
    Commercial...................      18,982        15,835           11,210  
    Consumer.....................       6,361         6,801            3,670  
                                     --------       -------          -------  
         Total loans originated..    $105,407      $ 79,235         $ 62,928  
                                     ========       =======          =======  
                                                                              
  Loans purchased:                                                            
    Real estate loans............    $    135      $     96         $     15  
    Other loans..................          18            --               --  
                                     --------      --------         --------  
       Total loans purchased.....    $    153      $     96         $     15  
                                     ========      ========         ========  
                                                                              
  Loans sold: (1)................    $ 27,635      $  9,166         $  9,181  
                                     ========      ========         ========  

</TABLE>

---------------------------
(1) All loans sold were whole loans.

       Our loan originations are derived from a number of sources, including
referrals from depositors and borrowers, repeat customers, advertising and
calling officers, as well as walk-in customers. Our solicitation programs
consist of advertisements in local media and participation in various community
organizations and events. Real estate loans are originated by our loan
personnel. All of our loan personnel are salaried and are eligible to receive
commissions for loans originated. We accept loan applications at our offices and
do not originate loans on an indirect basis such as through arrangements with
automobile dealers. In all cases, we have final approval of the application.
Historically, we have purchased limited quantities of loans. During the years
ended September 30, 1998, 1997 and 1996, virtually all loans purchased were
small participation interests in multi-family residential real estate loans to
finance low income housing.

       In recent years, and particularly during the year ended September 30,
1998, we have sold an increasing amount of fixed-rate, single-family mortgage
loans that we originated. During the years ended September 30, 1998, 1997 and
1996, we sold $27.6 million, $9.2 million and $9.2 million, respectively, of
such loans. Typically, in the current low interest rate environment, we have
been selling fixed-rate, single-family mortgage loans with terms of 15 years or
more 

                                       52
<PAGE>
 
except in cases where the interest rate is sufficient to compensate us for the
risk of retaining a long-term, fixed-rate loan in our portfolio. Most loans have
been sold to private purchasers with servicing released. In addition, a smaller
amount of loans are sold in the secondary market to the FHLMC. We retain
servicing on loans sold to the FHLMC.

       Loan Underwriting Policies. Our lending activities are subject to our
written, non-discriminatory underwriting standards and to loan origination
procedures prescribed by our Board of Directors and management. Detailed loan
applications are obtained to determine the borrower's ability to repay, and the
more significant items on these applications are verified through the use of
credit reports, financial statements and confirmations. Individual officers have
been granted authority by the Board of Directors to approve mortgage, consumer
and commercial loans up to varying specified dollar amounts, depending upon the
type of loan. A loan committee consisting of our President, Executive Vice
President, Chief Financial Officer, senior credit officer and head of mortgage
lending has authority to approve any loan in an amount exceeding individual
lending authorities where our total loans to that borrower would not exceed
$350,000. Our executive committee, which consists of the Chairman of the Board,
the President, two additional Board members that serve on a permanent basis and
one Board member selected on a rotating basis that serves for a three-month
period, has authority to approve any loan where our total loans to that borrower
would not exceed $1.0 million. Loans above that amount may not be made unless
approved by the full Board of Directors. These authorities are based on
aggregate borrowings of an individual or entity. On a monthly basis, the full
Board of Directors reviews the actions taken by the loan committee and the
executive committee.

       Applications for single-family real estate loans are underwritten and
closed in accordance with the standards of FHLMC. Generally, upon receipt of a
loan application from a prospective borrower, a credit report and verifications
are ordered to verify specific information relating to the loan applicant's
employment, income and credit standing. If a proposed loan is to be secured by a
mortgage on real estate, an appraisal of the real estate is usually undertaken
by an appraiser approved by us and licensed by the State of North Carolina.
Except when we become aware of a particular risk of environmental contamination,
we generally do not obtain a formal environmental report on real estate at the
time a loan is made.

       Our policy is to record a lien on the real estate securing a loan and to
obtain title insurance which insures that the property is free of prior
encumbrances and other possible title defects. Borrowers must also obtain hazard
insurance policies prior to closing and, when the property is in a flood plain
as designated by the Department of Housing and Urban Development, pay flood
insurance policy premiums.

       With respect to single-family residential mortgage loans, we make a loan
commitment of between 30 and 60 days for each loan approved. If the borrower
desires a longer commitment, the commitment may be extended for good cause and
upon written approval. The interest rate is guaranteed for the commitment
period.

       We are permitted to lend up to 95% of the lesser of the appraised value
or the purchase price of the real property securing a mortgage loan. However, if
the amount of a residential loan originated or refinanced exceeds 80% of the
appraised value, our policy generally is to obtain private mortgage insurance at
the borrower's expense on that portion of the principal amount of the loan that
exceeds 80% of the appraised value of the property. We will make a single-family
residential mortgage loan with up to a 95% loan-to-value ratio if the required
private mortgage insurance is obtained. We generally limit the loan-to-value
ratio on commercial real estate mortgage loans to 80%, although the loan-to-
value ratio on commercial real estate loans in limited circumstances has been as
high as 85%. We limit the loan-to-value ratio on multi-family residential real
estate loans to 80%.

       Under applicable law, with certain limited exceptions, loans and
extensions of credit by a savings institution to a person outstanding at one
time and not fully secured by collateral having a market value at least equal to
the amount of the loan or extension of credit shall not exceed 15% of net worth
plus the general loan loss reserve. Loans and extensions of credit fully secured
by readily marketable collateral may comprise an additional 10% of net worth.
Applicable law additionally authorizes savings institutions to make loans to one
borrower, for any purpose: (i) in an amount not to exceed $500,000; (ii) in an
amount not to exceed the lesser of $30,000,000 or 30% of net worth to

                                       53
<PAGE>
 
develop residential housing, provided (a) the purchase price of each single-
family dwelling in the development does not exceed $500,000 and (b) the
aggregate amount of loans made under this authority does not exceed 150% of net
worth; or (iii) loans to finance the sale of real property in satisfaction of
debts previously contracted in good faith, not to exceed 50% of net worth. Under
these limits, our loans to one borrower were limited to $4.4 million at
September 30, 1998. At that date, we had no lending relationships in excess of
the loans-to-one-borrower limit. At September 30, 1998, our ten largest lending
relationships ranged in size from $2.4 million to $4.3 million.

       Single-Family Residential Real Estate Lending. We historically have been
and continue to be an originator of single-family, residential real estate loans
in our market area. At September 30, 1998, single-family, residential mortgage
loans, excluding home equity loans, totaled $100.9 million, or 48.8% of our
gross loan portfolio.

       We originate fixed-rate mortgage loans at competitive interest rates. At
September 30, 1998, $68.8 million, or 33.3%, of our gross loan portfolio was
comprised of fixed-rate, single-family mortgage loans. Generally, in the
currently low interest rate environment, we have been retaining fixed-rate
mortgages with maturities of ten years or less while fixed-rate loans with
longer maturities are being sold in the secondary market.

       We also offer adjustable-rate residential mortgage loans. The adjustable-
rate loans we currently offer have interest rates which adjust every one, three
or five years from the closing date of the loan or on an annual basis commencing
after an initial fixed-rate period of three or five years in accordance with a
designated index, plus a stipulated margin. The primary index we utilize is the
weekly average yield on U.S. Treasury securities adjusted to a constant
comparable maturity equal to the loan adjustment period, as made available by
the Federal Reserve Board (the "Treasury Rate"). The maximum adjustment on the
bulk of our loans is 2% per adjustment period with a maximum aggregate
adjustment of 6% over the life of the loan. We offer adjustable-rate mortgage
loans that provide for initial rates of interest slightly below the rates that
would prevail when the index used for repricing is applied, i.e., "teaser"
rates. All of our adjustable-rate loans require that any payment adjustment
resulting from a change in the interest rate of an adjustable-rate loan be
sufficient to result in full amortization of the loan by the end of the loan
term and, thus, do not permit any of the increased payment to be added to the
principal amount of the loan, or so-called negative amortization. At September
30, 1998, $32.1 million, or 31.8%, of our single-family residential mortgage
loans were adjustable-rate loans.

       The retention of adjustable-rate loans in our portfolio helps reduce our
exposure to increases or decreases in prevailing market interest rates. However,
there are unquantifiable credit risks resulting from potential increases in
costs to borrowers in the event of upward repricing of adjustable-rate loans. It
is possible that during periods of rising interest rates, the risk of default on
adjustable-rate loans may increase due to increases in interest costs to
borrowers. Further, although adjustable-rate loans allow us to increase the
sensitivity of our interest-earning assets to changes in interest rates, the
extent of this interest sensitivity is limited by the initial fixed-rate period
before the first adjustment and the lifetime interest rate adjustment
limitations. Accordingly, there can be no assurance that yields on our
adjustable-rate loans will fully adjust to compensate for increases in our cost
of funds.

       Commercial Real Estate Lending. Our commercial real estate loan portfolio
includes loans secured by small office buildings, commercial and industrial
buildings and small apartment buildings. Such loans generally range in size from
$100,000 to $3.3 million. At September 30, 1998, our commercial real estate
loans totaled $38.8 million, which amounted to 18.8%, of our gross loan
portfolio. We originate commercial real estate loans for terms of up to 15 years
and with interest rates that adjust daily based on our prime rate plus a
negotiated margin typically up to 1% or that carry predetermined rates fixed for
one, three or five years.

       Commercial real estate lending entails significant additional risks as
compared with single-family residential property lending. Commercial real estate
loans typically involve larger loan balances to single borrowers or groups of
related borrowers. The payment experience on such loans typically is dependent
on the successful operation of the real estate project, retail establishment,
apartment building or business. These risks can be significantly affected by
supply and demand conditions in the market for office, retail and residential
space, and, as such, may be subject to a greater

                                       54
<PAGE>
 
extent to adverse conditions in the economy generally. To minimize these risks,
we generally originate loans secured by collateral located in our market area or
to borrowers with which we have prior experience or who are otherwise known to
us. It has been our policy to obtain annual financial statements of the business
of the borrower or the project for which commercial real estate loans are made.
In addition, in the case of commercial mortgage loans made to a partnership or a
corporation, we seek, whenever possible, to obtain personal guarantees and
annual financial statements of the principals of the partnership or corporation.

       Home Equity Loans. At September 30, 1998, we had approximately $16.9
million in home equity line of credit loans, representing approximately 8.2% of
our gross loan portfolio. Our home equity lines of credit generally have
adjustable interest rates tied to our prime interest rate plus a margin,
although we currently are offering a program where the interest rate on home
equity loans will be fixed for one or two years. Home equity lines of credit
must be repaid in 15 years or less and require monthly interest payments. Home
equity lines of credit generally are secured by subordinate liens against
residential real property. We require that fire and extended coverage casualty
insurance (and, if appropriate, flood insurance) be maintained in an amount at
least sufficient to cover the loan. Home equity loans generally are limited so
that the amount of such loans, along with any senior indebtedness, does not
exceed 80% of the value of the real estate security.

       Construction Lending. We offer residential and commercial construction
loans, with a significant portion of such loans originated to date being for the
construction of owner-occupied, single-family dwellings in our market area.
Residential construction loans are offered primarily to individuals building
their primary or secondary residence, as well as to selected local developers to
build single-family dwellings. In addition, on occasion, we make acquisition and
development loans to local developers to acquire and develop land for sale to
builders who will construct single-family residences. At September 30, 1998,
$18.6 million, or 9.0%, of our gross loan portfolio consisted of construction
loans.

       Generally, loans to owner/occupants for the construction of owner-
occupied, single-family residential properties are originated in connection with
the permanent loan on the property and have a construction term of six to 12
months. Such loans are offered on an adjustable-rate basis. Interest rates on
residential construction loans made to the owner/occupant have interest rates
during the construction period equal to our prime rate. Upon completion of
construction, the loan is converted into a one-year adjustable-rate loan, and
the owner may lock in a fixed-rate loan at any time during the one-year period.

       We make construction loans to builders on either a pre-sold or
speculative (unsold) basis. However, we limit the number of outstanding loans on
unsold homes under construction to individual builders, with the amount
dependent on the financial strength of the builder, the present exposure of the
builder, the location of the property and prior sales of homes in the
development. At September 30, 1998, speculative construction loans amounted to
$5.8 million. At September 30, 1998, the largest amount of construction loans
outstanding to one builder was $600,000, all of which was for speculative
construction. Interest rates on residential construction loans to builders are
set at our prime rate plus a margin typically up to 1% and adjust with changes
in the prime rate, and are made for terms of up to 24 months.

       Interest rates on commercial construction loans are based on the prime
rate plus a negotiated margin typically up to 1%, and adjust with changes in our
prime rate, and are made for terms of up to 24 months, with construction terms
generally not exceeding 12 months.

       Acquisition and development loans are made at a rate that adjusts
monthly, based on our prime rate plus a negotiated margin, for terms of up to
three years. Interest only is paid during the term of the loan, and the
principal balance of the loan is paid down as developed lots are sold to
builders. See "Risk Factors -- Risks Related to Commercial and Consumer
Lending." At September 30, 1998, we had eight such loans outstanding totaling
$4.1 million. All acquisition and development loans were performing in
accordance with their terms at such date.

       Prior to making a commitment to fund a construction loan, we require an
appraisal of the property by appraisers approved by the Board of Directors. We
also review and inspect each project at the commencement of construction and

                                       55
<PAGE>
 
either weekly or biweekly during the term of the construction loan. We may
charge a construction fee and/or an inspection fee on construction loans.
Advances are made on a percentage of completed basis.

       Construction financing generally is considered to involve a higher degree
of risk of loss than long-term financing on improved, occupied real estate. Risk
of loss on a construction loan is dependent largely upon the accuracy of the
initial estimate of the property's value at completion of construction or
development and the estimated cost (including interest) of construction. During
the construction phase, a number of factors could result in delays and cost
overruns. If the estimate of construction costs proves to be inaccurate and the
borrower is unable to meet our requirements of putting up additional funds to
cover extra costs or change orders, then we will demand that the loan be paid
off and, if necessary, institute foreclosure proceedings, or refinance the loan.
If the estimate of value proves to be inaccurate, we may be confronted, at or
prior to the maturity of the loan, with collateral having a value which is
insufficient to assure full repayment. We have sought to minimize this risk by
limiting construction lending to qualified borrowers (i.e., borrowers who
satisfy all credit requirements and whose loans satisfy all other underwriting
standards which would apply to our permanent mortgage loan financing for the
subject property) in our market area. On loans to builders, we work only with
selected builders with whom we have experience and carefully monitor the
creditworthiness of the builders.

       Commercial Lending. We originate commercial loans to small and medium
sized businesses in our market area. Our commercial borrowers are generally
small businesses engaged in manufacturing, distribution or retailing, or
professionals in healthcare, accounting and law. Commercial loans generally are
made to finance the purchase of inventory, new or used equipment or commercial
vehicles and for short-term working capital. Such loans generally are secured by
equipment and inventory, and, if possible, cross-collateralized by a real estate
mortgage, although commercial loans are sometimes granted on an unsecured basis.
Commercial loans generally are made for terms of five years or less, depending
on the purpose of the loan and the collateral, with loans to finance operating
expenses made for one year or less, with interest rates that adjust at least
annually at a rate equal to our prime rate plus a margin typically up to 2%.
Generally, commercial loans are made in amounts ranging between $50,000 and $1.0
million. At September 30, 1998, commercial loans totaled $25.2 million, or 12.2%
of our gross loan portfolio.

       We underwrite commercial loans on the basis of the borrower's cash flow
and ability to service the debt from earnings rather than on the basis of
underlying collateral value, and we seek to structure such loans to have more
than one source of repayment. The borrower is required to provide us with
sufficient information to allow us to make our lending determination. In most
instances, this information consists of at least two years of financial
statements, a statement of projected cash flows, current financial information
on any guarantor and any additional information on the collateral. For loans
with maturities exceeding one year, we require that borrowers and guarantors
provide updated financial information at least annually throughout the term of
the loan.

       Our commercial loans may be structured as term loans or as lines of
credit. Commercial term loans are generally made to finance the purchase of
assets and have maturities of five years or less. Commercial lines of credit are
typically made for the purpose of providing working capital and are usually
reviewed on an annual basis but may be called on demand. We also offer standby
letters of credit for commercial borrowers. Standby letters of credit are
written for a maximum term of one year.

       Commercial loans are often larger and may involve greater risk than other
types of lending. Because payments on such loans are often dependent on
successful operation of the business involved, repayment of such loans may be
subject to a greater extent to adverse conditions in the economy. We seek to
minimize these risks through our underwriting guidelines, which require that the
loan be supported by adequate cash flow of the borrower, profitability of the
business, collateral and personal guarantees of the individuals in the business.
In addition, we limit this type of lending to our market area and to borrowers
with which we have prior experience or who are otherwise well known to us.

                                       56
<PAGE>
 
       Consumer Lending. In recent years, we have gradually increased our
portfolio of consumer loans. Our consumer loans include automobile loans,
savings account loans, unsecured lines of credit and miscellaneous other
consumer loans, including unsecured loans. At September 30, 1998, the Bank's
consumer loans totaled $6.3 million, or 3.1% of our gross loan portfolio.

       Automobile loans are generally underwritten in amounts up to 80% of the
lesser of the purchase price of the automobile or, with respect to used
automobiles, the loan value as published by the National Automobile Dealers
Association. The terms of most such loans do not exceed 72 months. We require
that the vehicles be insured and that we be listed as loss payee on the
insurance policy.

       We make savings account loans for up to 90% of the depositor's savings
account balance. The interest rate is normally 2.5% above the annual percentage
yield paid on the savings account. The account must be pledged as collateral to
secure the loan. Interest generally is paid on a monthly basis.

       Consumer lending affords us the opportunity to earn yields higher than
those obtainable on single-family residential lending. However, consumer loans
entail greater risk than do residential mortgage loans, particularly in the case
of loans which are unsecured (as is the case with lines of credit) or secured by
rapidly depreciable assets such as automobiles. Repossessed collateral for a
defaulted consumer loan may not provide an adequate source of repayment of the
outstanding loan balance as a result of the greater likelihood of damage, loss
or depreciation. The remaining deficiency often does not warrant further
substantial collection efforts against the borrower. In addition, consumer loan
collections are dependent on the borrower's continuing financial stability, and
thus are more likely to be adversely affected by events such as job loss,
divorce, illness or personal bankruptcy. Further, the application of various
state and federal laws, including federal and state bankruptcy and insolvency
law, may limit the amount which may be recovered. In underwriting consumer
loans, we consider the borrower's credit history, an analysis of the borrower's
income and ability to repay the loan, and the value of the collateral.

       Loan Fees and Servicing. We receive fees in connection with late payments
and for miscellaneous services related to our loans and deposits. We also charge
fees in connection with loan originations. These fees can consist of
origination, discount, construction and/or commitment fees, depending on the
type of loan. We generally do not service loans for others except for mortgage
loans we originate and sell with servicing retained. Mortgage servicing rights
were not material for any of the periods presented.

       Nonperforming Loans and Other Problem Assets. We continually monitor our
loan portfolio to anticipate and address potential and actual delinquencies.
When a borrower fails to make a payment on a loan, we take immediate steps to
have the delinquency cured and the loan restored to current status. Loans which
are delinquent more than 15 days incur a late fee of 4% of the monthly payment
of principal and interest due. As a matter of policy, we will contact the
borrower after the loan has been delinquent 15 days. If payment is not promptly
received, the borrower is contacted again, and efforts are made to formulate an
affirmative plan to cure the delinquency. Generally, after any loan is
delinquent 45 days or more, we send a default letter to the borrower. If the
default is not cured after 30 days, we commence formal legal proceedings to
collect amounts owed.

       Generally we charge-off or reserve through an allowance account interest
on loans, including impaired loans, that are contractually ninety days or more
past due. The allowance is established by a charge to interest income equal to
all interest previously accrued. In certain circumstances, interest on loans
that are contractually ninety days or more past due is not charged off or
reserved through an allowance account when we believe that the loan is both well
secured and in the process of collection. If amounts are received on loans for
which the accrual of interest has been discontinued, we decide whether payments
received should be recorded as a reduction of the principal balance or as
interest income depending on our analysis of the collectibility of principal.
The loan is returned to accrual status when we believe the borrower has
demonstrated the ability to make periodic interest and principal payments on a
timely basis.

                                       57
<PAGE>
 
       Real estate acquired as a result of foreclosure is classified as real
estate acquired in settlement of loans until such time as it is sold and is
recorded at the lower of the estimated fair value of the underlying real estate
or the carrying amount of the loan. Subsequent costs directly related to
development and improvement of property are capitalized, whereas costs related
to holding property are expensed. Any required write-down of the loan to its
fair value less estimated selling costs upon foreclosure is charged against the
allowance for loan losses. See Note 1 of Notes to Consolidated Financial
Statements.

       The following table sets forth information with respect to our
nonperforming assets at the dates indicated. At the dates shown, we had no
restructured loans within the meaning of Statement of Financial Accounting
Standards No. 114, as amended.

<TABLE>
<CAPTION>
                                                                           AT SEPTEMBER 30,
                                                     ----------------------------------------------------------------
                                                       1998         1997         1996         1995            1994
                                                     ---------    ---------    ---------    ---------      ----------
                                                                        (DOLLARS IN THOUSANDS)
<S>                                                  <C>          <C>          <C>          <C>            <C>
Loans accounted for on a nonaccrual basis (1)......  $    263     $    259     $    288     $  3,661       $     99
                                                     ========     ========     ========     ========       ========
 
Accruing loans which are contractually past due
  90 days or more..................................  $     --     $     --     $     --     $     --       $     --
                                                     ========     ========     ========     ========       ========
 
      Total nonperforming loans....................  $    263     $    259     $    288     $  3,661       $     99
                                                     ========     ========     ========     ========       ========
 
Total loans........................................  $200,010     $199,876     $176,345     $173,316       $155,962
                                                     ========     ========     ========     ========       ========
Percentage of total loans..........................      0.13%        0.13%        0.16%        2.11%          0.06%
                                                     ========     ========     ========     ========       ========
Other non-performing assets (2)....................  $     --     $     --     $      1     $      1       $  3,202
                                                     ========     ========     ========     ========       ========
Loans modified in troubled debt restructuring......  $     --     $     --     $     --     $     --       $     --
                                                     ========     ========     ========     ========       ========
</TABLE>

--------------------
(1)    Payments received on a non-accrual loan are either applied to the
       outstanding principal balance or recorded as interest income, depending
       on management's assessment of the collectibility of the loan.

(2)    Other non-performing assets consist of  property acquired through
       foreclosure or repossession.

       During the years ended September 30, 1998, 1997 and 1996, gross interest
income of $10,000, $27,000 and $26,000, respectively, would have been recorded
on loans accounted for on a nonaccrual basis if the loans had been current
throughout the year. Interest on such loans included in income during the years
ended September 30, 1998, 1997 and 1996 amounted to $15,000, $16,000 and
$12,000, respectively.

       At September 30, 1998 there were no loans which are not currently
classified as non-accrual, 90 days past due or restructured but where known
information about possible credit problems of borrowers causes management to
have serious concerns as to the ability of the borrowers to comply with present
loan repayment terms and may result in disclosure as nonaccrual, 90 days past
due or restructured. See " -- Classified Assets" for information regarding loans
classified as special mention or watch.

      At September 30, 1998, an analysis of our portfolio did not reveal any
impaired loans that needed to be classified under SFAS No. 114.

       At September 30, 1998, we had $263,000 of nonaccrual loans, which
consisted of four single-family mortgage loans.    At September 30, 1998, we
did not have any real estate owned.

       Classified Assets. Regulations require that we classify our assets on a
regular basis. In addition, in connection with examinations of insured
institutions, examiners have authority to identify problem assets and if
appropriate, classify them in their reports of examination. There are three
classifications for problem assets: "substandard," "doubtful" and "loss."
Substandard assets have one or more defined weaknesses and are characterized by
the distinct possibility that  

                                       58
<PAGE>
 
the insured institution will sustain some loss if the deficiencies are not
corrected. Doubtful assets have the weaknesses of substandard assets with the
additional characteristic that the weaknesses make collection or liquidation in
full, on the basis of currently existing facts, conditions and values,
questionable, and there is a high possibility of loss. An asset classified loss
is considered uncollectible and of such little value that continuance as an
asset of the institution is not warranted. Assets classified as substandard or
doubtful require a savings institution to establish general allowances for loan
losses. If an asset or portion thereof is classified loss, a savings institution
must either establish a specific allowance for loss in the amount of the portion
of the asset classified loss, or charge off such amount. The Bank regularly
reviews its assets to determine whether any assets require classification or re-
classification. At September 30, 1998, we had $1.0 million in classified assets
consisting of $990,000 in assets classified as substandard, $20,000 in assets
classified as doubtful and no assets classified as loss.

       In addition to regulatory classifications, we also classify as special
mention or watch assets that are currently performing in accordance with their
contractual terms but may be classified or nonperforming assets in the future.
At September 30, 1998 we have identified approximately $11.5 million in assets
classified as special mention or watch. Included in this amount are three loans
with an aggregate outstanding balance of $3.5 million at September 30, 1998 to a
company affiliated with one of our directors. In addition to the outstanding
balance on the loans, the borrower has the ability to borrow an additional
$256,000 from us under lines of credit. All the loans are secured by a first
lien on all company assets, including accounts receivable, inventory, equipment,
furniture and real property occupied by the borrower. In addition, the director
has personally guaranteed repayment of the loans. At September 30, 1998, such
loans were current with respect to their payment terms and, except for the
waiver of certain debt covenants by the Bank, were performing in accordance with
the related loan agreements. Based on an analysis of the borrower's current
financial statements, management has concerns that the borrower may have
difficulty in complying with the present loan repayment terms on an ongoing
basis.

       Allowance for Loan Losses. Our policy is to establish reserves for
estimated losses on delinquent loans when we determine that losses are expected
to be incurred on such loans. We maintain the allowance for losses on loans at a
level we believe to be adequate to absorb potential losses in the portfolio. Our
determination of the adequacy of the allowance is based on an evaluation of the
portfolio, past loss experience, current economic conditions, volume, growth and
composition of the portfolio, and other relevant factors. The allowance is
increased by provisions for loan losses which are charged against income.

       Although we believe we use the best information available to make
determinations with respect to the allowance for losses and believe such
allowances are adequate, future adjustments may be necessary if economic
conditions differ substantially from the economic conditions in the assumptions
used in making the initial determinations. We anticipate that our allowance for
loan losses will increase in the future as we implement the Board of Directors'
strategy of continuing existing lines of business while gradually expanding
commercial and consumer lending, which loans generally entail greater risks than
single-family residential mortgage loans.

       Banking regulatory agencies, including the FDIC, have adopted a policy
statement regarding maintenance of an adequate allowance for loan and lease
losses and an effective loan review system. This policy includes an arithmetic
formula for checking the reasonableness of an institution's allowance for loan
loss estimate compared to the average loss experience of the industry as a
whole. Examiners will review an institution's allowance for loan losses and
compare it against the sum of: (i) 50% of the portfolio that is classified
doubtful; (ii) 15% of the portfolio that is classified as substandard; and (iii)
for the portions of the portfolio that have not been classified (including those
loans designated as special mention), estimated credit losses over the upcoming
12 months given the facts and circumstances as of the evaluation date. This
amount is considered neither a "floor" nor a "safe harbor" of the level of
allowance for loan losses an institution should maintain, but examiners will
view a shortfall relative to the amount as an indication that they should review
management's policy on allocating these allowances to determine whether it is
reasonable based on all relevant factors.

                                       59
<PAGE>
 
       We have our own allowance for loan loss model which is similar to the
FDIC model. Our model indicated that the allowance for loan losses was adequate
at September 30, 1998.

       The following table sets forth an analysis of our allowance for loan
losses for the periods indicated.

<TABLE>
<CAPTION>
                                                                  YEAR ENDED SEPTEMBER 30,
                                                -----------------------------------------------------------
                                                   1998        1997         1996         1995        1994
                                                ---------    ---------   ---------    ----------   --------
                                                               (DOLLARS IN THOUSANDS)
<S>                                             <C>          <C>         <C>          <C>          <C>
 
Balance at beginning of period.............     $  2,754     $  2,496    $  2,223     $   1,767    $  1,540
                                                --------     --------    --------     ---------    --------
 
Loans charged off..........................            4            7          13             5          17
                                                --------     --------    --------     ---------    --------
 
Recoveries.................................            1            4           5             7           4
                                                --------     --------    --------     ---------    --------
 
Net loans charged off......................            3            3           8            (2)         13
                                                --------     --------    --------     ---------    --------
 
Provision for loan losses..................          477          261         281           454         240
                                                --------     --------    --------     ---------    --------
 
Balance at end of period...................     $  3,228     $  2,754    $  2,496     $   2,223    $  1,767
                                                ========     ========    ========     =========    ========
 
Average loans outstanding.................      $199,203     $186,413    $171,148     $ 165,347    $150,722
                                                ========     ========    ========     =========    ========
 
Ratio of net loans charged off to average
  loans outstanding during the period......       0.0015%      0.0016%     0.0047%      (0.0012)%    0.0086% 
                                                ========     ========    ========     =========    ========
</TABLE> 
 

                                       60
<PAGE>
 
       The following table allocates the allowance for loan losses by loan
category at the dates indicated. The allocation of the allowance to each
category is not necessarily indicative of future losses and does not restrict
the use of the allowance to absorb losses in any category.

<TABLE>
<CAPTION>
                                                                         AT SEPTEMBER 30,
                             -------------------------------------------------------------------------------------------------------
                                     1998                 1997                 1996                1995                  1994
                             -------------------  -------------------  -------------------  -------------------  -------------------
                                     PERCENT OF           PERCENT OF           PERCENT OF           PERCENT OF           PERCENT OF 
                                       LOANS IN             LOANS IN             LOANS IN             LOANS IN             LOANS IN 
                                     CATEGORY TO          CATEGORY TO          CATEGORY TO          CATEGORY TO          CATEGORY TO
                             AMOUNT  TOTAL LOANS  AMOUNT  TOTAL LOANS  AMOUNT  TOTAL LOANS  AMOUNT  TOTAL LOANS  AMOUNT  TOTAL LOANS
                             ------  -----------  ------  -----------  ------  -----------  ------  -----------  ------  -----------
                                                                     (DOLLARS IN THOUSANDS)
<S>                          <C>     <C>          <C>     <C>          <C>     <C>          <C>     <C>          <C>     <C>
Real estate mortgage:                                                      
 Single-family residential.. $  400     48.84%    $  376     53.76%    $  387     55.70%    $  326     55.78%    $  277     57.51%
 Commercial.................    898     18.76        854     17.02        882     19.62        788     20.23        583     18.89
 Home equity................    319      8.17        318      8.99        303      8.82        272      9.28        233      9.67
 Construction...............    458      8.99        380      6.24        232      4.36        235      4.01        173      3.58
Commercial..................    815     12.19        540     11.34        450      9.44        374      8.52        294      8.13
Consumer....................    338      3.05        286      2.65        242      2.06        228      2.18        207      2.22
                             ------    ------     ------    ------     ------    ------     ------    ------     ------    ------
   Total allowance for
     loan losses............ $3,228    100.00%    $2,754    100.00%    $2,496    100.00%    $2,223    100.00%    $1,767    100.00%
                             ======    ======     ======    ======     ======    ======     ======    ======     ======    ======
</TABLE>

                                       61
<PAGE>
 
INVESTMENT ACTIVITIES

       General. Interest income from investment securities generally provides
our second largest source of income after interest on loans. The Board of
Directors has authorized investment in U.S. Government and agency securities,
state government obligations, municipal securities, obligations of the FHLB,
mortgage-backed securities issued by FNMA, the GNMA and FHLMC and any other
securities authorized by the Administrator as permissible investments. Our
objective is to use such investments to reduce interest rate risk, enhance
yields on assets and provide liquidity. At September 30, 1998, the amortized
cost of our investment securities portfolio amounted to $39.9 million, which
included $34.1 million of U.S. Government and agency securities, $1.7 million of
mortgage-backed securities and $108,000 of collateralized mortgage obligations
("CMO's"). In addition, at September 30, 1998, we had a $4.0 million investment
in two mutual funds that invest in U.S. Government and agency securities and
mortgage-backed securities. At such date, we had an unrealized gain of $93,000,
net of deferred taxes, with respect to our investment securities classified as
available for sale.

       The Board of Directors has established an investment policy that sets
forth investment and aggregate investment limitations and credit quality
parameters of each class of investment security. Securities purchases are
subject to the oversight of our Executive Committee. The President has authority
to make specific investment decisions within the parameters determined by the
Board of Directors.

       Pursuant to SFAS No. 115, we had securities with an aggregate cost of
$9.7 million and an approximate fair value of $9.9 million at September 30, 1998
as available for sale. The impact on our financial statements was an after-tax
increase in net worth of approximately $93,000 as of September 30, 1998. The
unrealized gains at September 30, 1998 in our portfolio of investment securities
and mortgage-backed securities were due to decreases in interest rates
subsequent to the acquisition of such securities. Securities designated as "held
to maturity" are those assets which we have the ability and intent to hold to
maturity. Upon acquisition, securities are classified as to our intent. The held
to maturity investment portfolio is not used for speculative purposes and is
carried at amortized cost. Securities designated as "available for sale" are
those assets which we may not hold to maturity and thus are carried at fair
value with unrealized gains or losses, net of tax effect, recognized in net
worth.

       Management periodically evaluates investment securities for other than
temporary declines in value and records any losses through an adjustment to
earnings. During the year ended September 30, 1998, we recognized a loss of
approximately $269,000 on the write down of marketable equity securities for an
other than temporary decline in value.

       At September 30, 1998, we had $4.0 million of U.S. Government and agency
securities classified as available for sale, which carry unrealized after-tax
gains of $26,000, and $30.1 million of U.S. Government and agency securities
classified as held to maturity. We attempt to maintain a high degree of
liquidity in our investment securities portfolio by choosing those that are
readily marketable. As of September 30, 1998, the estimated weighted average
life of our U.S. Government and agency securities was approximately 4 years, and
the average yield on our portfolio of U.S. Government and agency securities was
6.22%. In addition, at September 30, 1998, we had $1.3 million of FHLB of
Atlanta stock.

       Mortgage-Backed and Related Securities. Included in our portfolio of
investment securities are mortgage-backed and mortgage-related securities.
Mortgage-backed securities represent a participation interest in a pool of
single-family or multi-family mortgages, the principal and interest payments on
which are passed from the mortgage originators through intermediaries that pool
and repackage the participation interest in the form of securities to investors.
Such intermediaries may include quasi-governmental agencies such as FHLMC, FNMA
and GNMA which guarantee the payment of principal and interest to investors.
Mortgage-backed securities generally increase the quality of our assets by
virtue of the guarantees that back them, are more liquid than individual
mortgage loans and may be used to collateralize borrowings or other obligations.
 

                                       62
<PAGE>
 
       The FHLMC is a public corporation chartered by the U.S. Government and
owned by the 12 FHLBs and federally insured savings institutions. The FHLMC
issues participation certificates backed principally by conventional mortgage
loans. The FHLMC guarantees the timely payment of interest and the ultimate
return of principal on participation certificates. The FNMA is a private
corporation chartered by the U.S. Congress with a mandate to establish a
secondary market for mortgage loans. The FNMA guarantees the timely payment of
principal and interest on FNMA securities. FHLMC and FNMA securities are not
backed by the full faith and credit of the United States, but because the FHLMC
and the FNMA are U.S. Government-sponsored enterprises, these securities are
considered to be among the highest quality investments with minimal credit
risks.

       The GNMA is a government agency within the Department of Housing and
Urban Development which is intended to help finance government-assisted housing
programs. GNMA securities are backed by FHA-insured and VA-guaranteed loans, and
the timely payment of principal and interest on GNMA securities is guaranteed by
the GNMA and backed by the full faith and credit of the U.S. Government.

       Because the FHLMC, the FNMA and the GNMA were established to provide
support for low- and middle-income housing, there are limits to the maximum size
of loans that qualify for these programs. The limit for FNMA and FHLMC currently
is $227,150.

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

       Mortgage-backed securities generally yield less than the loans which
underlie such securities because of their payment guarantees or credit
enhancements which offer nominal credit risk. In addition, mortgage-backed
securities are more liquid than individual mortgage loans and may be used to
collateralize borrowings in the event that we determined to utilize borrowings
as a source of funds. Mortgage-backed securities issued or guaranteed by the
FNMA or the FHLMC (except interest-only securities or the residual interests in
CMOs, of which we own none) are weighted at no more than 20% for risk-based
capital purposes, compared to a weight of 50% to 100% for residential loans. See
"Regulation --Regulation of the Bank -- Capital Requirements."

       Our mortgage-backed and related securities portfolio consists primarily
of seasoned fixed-rate and adjustable-rate, mortgage-backed and related
securities. We make such investments in order to manage cash flow, diversify
assets, obtain yield and to satisfy certain requirements for favorable tax
treatment.

       At September 30, 1998, the weighted average contractual maturity of our
mortgage-backed securities, all of which carried fixed rates, was approximately
5 years. The actual maturity of a mortgage-backed security varies, depending on
when the mortgagors prepay or repay the underlying mortgages. Prepayments of the
underlying mortgages may shorten the life of the investment, thereby adversely
affecting its yield to maturity and the related market value of the mortgage-
backed security. The yield is based upon the interest income and the
amortization of the premium or accretion of the discount related to the 
mortgage-backed security. Premiums and discounts on mortgage-backed securities
are amortized or accreted over the estimated term of the securities using a
level yield method. The prepayment assumptions used to determine the
amortization period for premiums and discounts can significantly affect the
yield of the mortgage-backed security, and these assumptions are reviewed
periodically to reflect the actual prepayment. The actual prepayments of the
underlying mortgages depend on many factors, including the type of mortgage, the
coupon rate, the age of the mortgages, the geographical location of the
underlying real estate collateralizing the mortgages and general levels of
market interest rates. The difference between the interest rates on the
underlying mortgages and the prevailing mortgage interest rates is an important
determinant in the rate of prepayments. During periods of falling mortgage
interest rates, prepayments generally increase, and, conversely, during periods
of rising mortgage interest

                                       63
<PAGE>
 
rates, prepayments generally decrease. If the coupon rate of the underlying
mortgage significantly exceeds the prevailing market interest rates offered for
mortgage loans, refinancing generally increases and accelerates the prepayment
of the underlying mortgages.

       At September 30, 1998, mortgage-backed securities with an amortized cost
of $1.7 million and a carrying value of $1.8 million were held as available for
sale. No mortgage-backed securities were classified as held to maturity.
Mortgage-backed securities classified as available for sale are carried at fair
value. Unrealized gains and losses on available for sale mortgage-backed
securities are recognized as direct increases or decreases in net worth, net of
applicable income taxes. See Notes 1 and 2 of the Notes to Consolidated
Financial Statements. At September 30, 1998, our mortgage-backed securities had
a weighted average yield of 8.20%.

       Mortgage-related securities, which include CMOs, are typically issued by
a special purpose entity, which may be organized in a variety of legal forms,
such as a trust, a corporation or a partnership. The entity aggregates pools of
pass-through securities, which are used to collateralize the mortgage-related
securities. Once combined, the cash flows can be divided into "tranches" or
"classes" of individual securities, thereby creating more predictable average
lives for each security than the underlying pass-through pools. Accordingly,
under this security structure, all principal paydowns from the various mortgage
pools are allocated to a mortgage-related securities' class or classes
structured to have priority until it has been paid off. These securities
generally have fixed interest rates, and, as a result, changes in interest rates
generally would affect the market value and possibly the prepayment rates of
such securities.

       Some mortgage-related securities instruments are like traditional debt
instruments due to their stated principal amounts and traditionally defined
interest rate terms. Purchasers of certain other mortgage-related securities
instruments are entitled to the excess, if any, of the issuer's cash flows.
These mortgage-related securities instruments may include instruments designated
as residual interest and are riskier in that they could result in the loss of a
portion of the original investment. Cash flows from residual interests are very
sensitive to prepayments and, thus, contain a high degree of interest rate risk.
We do not purchase residual interests in mortgage-related securities.

       At September 30, 1998, we had within our investment securities portfolio
CMOs with an amortized cost of $108,000, representing less than .1% of total
assets. Our CMOs had a weighted average yield of 6.57% at September 30, 1998.

       The following table sets forth the carrying value of our investment
securities portfolio at the dates indicated.

<TABLE>
<CAPTION>
                                                        At September 30,       
                                                 ----------------------------  
                                                 1998        1997        1996  
                                                 ----        ----        ----  
                                                        (In thousands)         
<S>                                            <C>         <C>         <C>     
Securities available for sale:                                                 
  U.S. government and agency securities....    $  4,043    $  4,012    $  7,938
  FHLMC....................................         662       1,564       2,131
  GNMA.....................................       1,147       1,754       1,981
  FNMA.....................................          --          29          58
  Marketable equity securities (1).........       4,006       3,961       3,916
                                               --------    --------    --------
      Total................................    $  9,858    $ 11,320    $ 16,024
                                               ========    ========    ========
                                                                               
Securities held to maturity:                                                   
  U.S. government and agency securities....    $ 30,087    $ 23,338    $ 21,317
  CMOs.....................................         108         144         368
                                               --------    --------    --------
      Total................................    $ 30,195    $ 23,482    $ 21,685
                                               ========    ========    ======== 
</TABLE>

_________
(1)  Consists of an investment in two mutual funds.

                                       64
<PAGE>
 
       The following table sets forth the scheduled maturities, carrying values,
amortized cost and average yields for our investment securities and mortgage-
backed securities portfolio at September 30, 1998.

<TABLE>
<CAPTION>
                                          ONE YEAR OR LESS       ONE TO FIVE YEARS      FIVE TO TEN YEARS    MORE THAN TEN YEARS
                                         ------------------     ------------------     ------------------    -------------------
                                         CARRYING   AVERAGE     CARRYING   AVERAGE     CARRYING   AVERAGE     CARRYING   AVERAGE
                                           VALUE     YIELD        VALUE     YIELD        VALUE     YIELD        VALUE     YIELD
                                         --------   -------     --------   -------     --------   -------     --------   -------
                                                                         (DOLLARS IN THOUSANDS)
<S>                                      <C>        <C>         <C>        <C>         <C>        <C>        <C>         <C>
 Securities available for sale:
  U.S. government and agency
    securities........................   $     --      -- %     $  3,043     6.25%     $  1,000     6.23%     $     --      -- %
  Mortgage-backed securities..........         --      --             --       --           251     7.81         1,558     8.26
  Marketable equity securities (1)....         --      --          2,013     4.79         1,993     6.49            --      --
                                         --------               --------               --------               --------
       Total..........................   $     --      --       $  5,056     5.67      $  3,244     6.51      $  1,558     8.26
                                         ========               ========               ========               ========

Securities held to maturity:
  U.S. government and agency
    securities........................   $  3,992     6.13%     $ 15,471     6.18%     $  9,624     6.22%     $  1,000     7.00%
  CMOs................................         --      --             --       --            --       --           108     6.57
                                         --------               --------               --------               --------
       Total..........................   $  3,992     6.13      $ 15,471     6.18      $  9,624     6.22      $  1,108     6.96
                                         ========               ========               ========               ========
<CAPTION>
                                          TOTAL INVESTMENT PORTFOLIO
                                         -----------------------------
                                         CARRYING    MARKET    AVERAGE
                                           VALUE      VALUE     YIELD
                                         --------   --------   -------
<S>                                      <C>        <C>        <C>
Securities available for sale:
  U.S. government and agency
    securities........................   $  4,043   $  4,043     6.25%
  Mortgage-backed securities..........      1,809      1,809     8.20
  Marketable equity securities (1)....      4,006      4,006     5.64
                                         --------   --------
       Total..........................   $  9,858   $  9,858     6.34
                                         ========   ========

Securities held to maturity:
  U.S. government and agency
    securities........................   $ 30,087   $ 30,307     6.22%
  CMOs................................        108        108     6.57
                                         --------   --------
       Total..........................   $ 30,195   $ 30,415     6.22
                                         ========   ========
</TABLE> 

_________
(1)  Consists of an investment in two mutual funds.

                                       65
<PAGE>
 
DEPOSIT ACTIVITY AND OTHER SOURCES OF FUNDS

       General.  Deposits are our primary source of funds for lending,
investment activities and general operational purposes. In addition to deposits,
we derive funds from loan principal and interest repayments, maturities of
investment securities and interest payments thereon. Although loan repayments
are a relatively stable source of funds, deposit inflows and outflows are
significantly influenced by general interest rates and money market conditions.
Borrowings may be used on a short-term basis to compensate for reductions in the
availability of funds, or on a longer term basis for general operational
purposes. We have access to FHLB of Atlanta advances. Following the Bank
Conversion, we will continue to have access to FHLB of Atlanta advances.

       Deposits.  We attract deposits principally from within our market area by
offering a variety of deposit instruments, including checking accounts, money
market accounts, passbook and statement savings accounts, Individual Retirement
Accounts, and certificates of deposit which range in maturity from seven days to
five years. Deposit terms vary according to the minimum balance required, the
length of time the funds must remain on deposit and the interest rate.
Maturities, terms, service fees and withdrawal penalties for our deposit
accounts are established by us on a periodic basis. We review our deposit
pricing on a weekly basis. In determining the characteristics of our deposit
accounts, we consider the rates offered by competing institutions, lending and
liquidity requirements, growth goals and applicable regulations. Management
believes we price our deposits comparably to rates offered by our competitors.
We do not accept brokered deposits.

       We compete for deposits with other institutions in our market area by
offering competitively priced deposit instruments that are tailored to the needs
of our customers. Additionally, we seek to meet customers' needs by providing
convenient customer service to the community, efficient staff and convenient
hours of service. Substantially all of our depositors are North Carolina
residents. To provide additional convenience, we participate in the HONOR and
CIRRUS Automatic Teller Machine networks at locations throughout the world,
through which customers can gain access to their accounts at any time. To better
serve our customers, we have installed automatic teller machines at five office
locations.

                                     66
<PAGE>
 
       Our savings deposits at September 30, 1998 were represented by the
  various types of savings programs described below.

<TABLE>
<CAPTION>
 
  Weighted
  Average
  Interest         Minimum                                                    Minimum      Balance (in       Percentage of
    Rate           Term            Category                                   Amount       Thousands)        Total Deposits
 ---------        --------         --------                                   -------     -------------      --------------
 <S>              <C>             <C>                                         <C>          <C>               <C> 
    --             None            Non-interest-bearing checking accounts     $    100       $  8,624             3.66%
  2.29%            None            NOW accounts                                    300         25,080            10.64
  2.84             None            Savings Accounts                                100         28,091            11.92
  3.93             None            Money Market Accounts                         1,000         13,238             5.62
 
 
                                   Certificates of Deposit
                                   --------------------------------------
 
  4.26             3 months        Fixed-term, fixed-rate                          500            231             0.10
  4.95             6 months        Fixed-term, fixed-rate                          500          7,098             3.01
  4.94             7 months (1)    Fixed-term, fixed-rate                        5,000         44,862            19.04
  5.23             9 months        Fixed-term, fixed-rate                          500          2,123             0.90
  5.00             10 months       Fixed-term, fixed-rate                        5,000          4,910             2.08
  5.35             12 months       Fixed-term, fixed-rate                          500         41,125            17.45
  5.27             18 months       Floating rate IRA                                50          1,089             0.46
  5.49             18 months       Fixed-term, fixed-rate                          500          2,355             1.00
  4.74             20 months       Fixed-term, fixed-rate                          500             33             0.01
  5.41             24 months       Fixed-term, fixed-rate                          500          9,884             4.19
  5.75             30 months       Fixed-term, fixed-rate                          500         17,610             7.47
  5.45             36 months       Fixed-term, fixed-rate                          500          4,028             1.71
  5.52             48 months       Fixed-term, fixed-rate                          500          4,553             1.93
  5.58             60 months       Fixed-term, fixed-rate                          500         17,856             7.58
  5.14             7 to 365 days   Fixed-term, fixed-rate                      100,000          2,904             1.23
                                                                                             --------           ------
                                                                                             $235,694           100.00%
                                                                                             ========           ======
 </TABLE> 

-------------
  (1)  These certificates of deposit do not carry a penalty for early
       withdrawal. As a result, we believe that should interest rates increase
       materially after September 30, 1998, borrowers may withdraw funds
       invested in these certificates prior to maturity, causing our cost of
       funds to increase.

                                       67
<PAGE>
 
       The following table sets forth the distribution of our deposit accounts
  at the dates indicated and the change in dollar amount of deposits in the
  various types of accounts we offer between the dates indicated.

<TABLE>
<CAPTION>
                                 Balance at                            Balance at                            Balance at
                              September 30,     % of      Increase   September 30,     % of      Increase   September 30,     % of
                                   1998       Deposits   (Decrease)       1997       Deposits   (Decrease)       1996       Deposits
                              --------------  ---------  ----------  --------------  ---------  ----------  -------------- ---------
                                                                      (Dollars in thousands)
<S>                           <C>             <C>        <C>         <C>             <C>        <C>         <C>            <C>
Noninterest-bearing demand..       $  8,624       3.66%   $  2,078        $  6,546       2.85%   $  3,438      $  3,108     1.48%
Interest-bearing checking...         25,080      10.64         930          24,150      10.53       2,287        21,863    10.43
Money market accounts.......         13,238       5.62       2,120          11,118       4.85       2,006         9,112     4.35
Passbook and savings........         28,091      11.92         391          27,700      12.08        (764)       28,464    13.57
Certificates of deposit.....        160,661      68.16         834         159,827      69.69      12,667       147,160    70.17
                                   --------     ------    --------        --------    -------    --------      --------   ------
                                   $235,694     100.00%     $6,353        $229,341     100.00%    $19,634      $209,707   100.00%  
                                   ========     ======    ========        ========    =======    ========      ========   ======
</TABLE>

                                       68
<PAGE>
 
       The following table sets forth the average balances and average interest
  rates based on daily balances for various types of deposits at the dates
  indicated for each category of deposits presented.
  
<TABLE>
<CAPTION>
                                                              Year Ended September 30,
                                        ------------------------------------------------------------------
                                               1998                   1997                    1996
                                        ------------------    -------------------     --------------------
                                        Average    Average     Average    Average     Average     Average
                                        Balance      Rate      Balance      Rate      Balance       Rate
                                        --------   -------     -------    -------     -------     --------
                                                               (Dollars in thousands)
  <S>                                   <C>        <C>         <C>        <C>         <C>         <C>
  Noninterest-bearing demand........    $  6,417      --  %    $  4,972       -- %    $  3,056       -- %
  Interest-bearing checking.........      24,987      2.21       23,975      2.23       21,187      2.19
  Money market accounts.............      12,277      3.82       10,638      3.42        9,883      3.10
  Passbook and savings..............      28,017      2.85       28,650      2.85       29,051      2.85
  Certificates of deposit...........     159,053      5.36      152,231      5.27      142,655      5.50
                                        --------               --------               --------      
      Total.........................    $230,751      4.48     $220,466      4.42     $205,832      4.59
                                        ========               ========               ========   
</TABLE>

       The following table sets forth our time deposits classified by rates at
  the dates indicated.
  
<TABLE> 
<CAPTION> 
                                                                  At September 30,
                                                     ----------------------------------------
                                                       1998            1997             1996
                                                     -------          ------           ------
                                                                  (In thousands)
  <S>                                                <C>            <C>               <C> 
  2 - 3.99%....................................      $     --       $    220          $    294
  4 - 5.99%....................................       149,064        147,667           129,549
  6 - 7.99%....................................        11,496         11,843            17,228
  8 - 9.99%....................................           101             97                89
                                                     --------       --------          --------
                                                     $160,661       $159,827          $147,160
                                                     ========       ========          ========
</TABLE> 

       The following table sets forth the amount and maturities of our time
  deposits at September 30, 1998.

<TABLE>
<CAPTION>
                                                     Amount Due
                                 -----------------------------------------------
                                 Less Than                                After
Rate                             One Year     1-2 Years    2-3 Years     3 Years       Total
----                             ---------    ---------    ---------     -------      ------
                                                     (In thousands)              
<S>                             <C>           <C>          <C>          <C>          <C>
4.00 - 5.99%................    $108,512      $  22,193    $  10,390    $  7,969    $  149,064
6.00 - 7.99%................       8,016          3,020          253         207        11,496
8.00 - 9.99%................          --             --           --         101           101
                                --------      ---------    ---------    --------     ---------
                                $116,528      $  25,213    $  10,643    $  8,277    $  160,661
                                ========      =========    =========    ========     =========
</TABLE>

                                       69
<PAGE>
 
       The following table indicates the amount of our certificates of deposit
  of $100,000 or more by time remaining until maturity as of September 30, 1998.
  At that date, such deposits represented 12.6% of total deposits and had a
  weighted average rate of 5.41%.
 
                                                    Certificates
                Maturity Period                     of Deposit
                ---------------                     -------------
                                                   (In thousands)
 
                Three months or less.............      $ 9,937
                Over three through six months....        6,050
                Over six through 12 months.......        9,276
                Over 12 months...................        4,437
                                                       -------
                Total............................      $29,700
                                                       =======
 
       We estimate that more than $29 million of certificates of deposit in
  amounts of $100,000 or more maturing within one year of September 30, 1998
  were held by retail and commercial customers of the Bank, while the remainder
  of such deposits were from schools, municipalities and other public entities
  and were obtained through competitive rate bidding.  We believe certificates
  of deposits held by our retail and commercial customers are more likely to be
  renewed upon maturity than certificates of deposit obtained through
  competitive bidding.

       The following table sets forth our savings activities for the periods
  indicated.

<TABLE>
<CAPTION>
                                                             Year Ended September 30,
                                                       -------------------------------------
                                                        1998           1997           1996
                                                       ------         ------         ------
                                                                    (In thousands)
  <S>                                                   <C>           <C>           <C>
  Net increase (decrease) before interest credited..    $(3,026)      $10,693       $   163
  Interest credited.................................      9,379         8,941         8,775
                                                        -------       -------       -------
      Net increase in deposits......................    $ 6,353       $19,634       $ 8,938
                                                        =======       =======       =======
  </TABLE>

       In the unlikely event the Bank is liquidated after the Stock Conversion,
  depositors will be entitled to full payment of their deposit accounts prior to
  any payment being made to the sole stockholder of the Converted Bank, which is
  the Company.

       Borrowings.  Savings deposits historically have been the primary source
  of funds for our lending, investments and general operating activities.  We
  are authorized, however, to use advances from the FHLB of Atlanta to
  supplement our supply of lendable funds and to meet deposit withdrawal
  requirements.  The FHLB of Atlanta functions as a central reserve bank
  providing credit for savings institutions and certain other member financial
  institutions.  As a member of the FHLB System, we are required to own stock in
  the FHLB of Atlanta and are authorized to apply for advances.  Advances are
  obtained pursuant to several different programs, each of which has its own
  interest rate and range of maturities.  We have a Blanket Agreement for
  advances with the FHLB under which we may borrow up to 25% of assets subject
  to normal collateral and underwriting requirements.  Advances from the FHLB of
  Atlanta are secured by our stock in the FHLB of Atlanta and other eligible
  assets.  We will remain as a member of the FHLB system following the Bank
  Conversion.

       In February 1998, we obtained $20.0 million in fixed-rate FHLB of Atlanta
  advances.  These advances were structured with maturities estimated to
  coincide with the expected repricing of $20.0 million of loans.  Through this
  strategy, we were able to establish a positive interest rate spread on the
  $20.0 million of assets and FHLB of Atlanta 

                                       70
<PAGE>
 
  advances.  See "Management's Discussion and Analysis of Financial Condition
  and Results of Operations --Asset/Liability Management."

       The following table sets forth certain information regarding our short-
  term borrowings at the dates and for the periods indicated:

  
                                                         At or For the
                                                     Year Ended September 30,
                                                  -----------------------------
                                                      1998     1997       1996
                                                      -----    ----       -----
                                                   (Dollars in thousands)

  Amounts outstanding at end of period:
    FHLB advances.........................          $20,000   $1,000     $1,000
  Weighted average rate paid on:   
    FHLB advances.........................             5.39%    5.57%      5.48%
   

                                                          For the Year
                                                        Ended September 30,
                                                  -----------------------------
                                                     1998      1997       1996
                                                     ----      ----       ----
                                                           (In thousands)
  Maximum amount of borrowings outstanding
  at any month end:
    FHLB advances ......................            $21,000   $1,000     $2,000
 
 
                                                         For the Year
                                                        Ended September 30,
                                                  -----------------------------
                                                     1998     1997       1996
                                                    -----     ----       ----
                                                      (Dollars in thousands)
  Average amounts outstanding:
    FHLB advances..........................         $13,559   $1,000     $ 156
  Approximate weighted average rate paid on: (1)
    FHLB advances..........................            5.46%    5.60%     1.92%
  
  -------------------------
  (1)  Based on month-end balances.


  SUBSIDIARY ACTIVITIES

       In prior years, we had one subsidiary, First Capital Services, Inc., a
  North Carolina corporation ("First Capital"), that engaged in sales of
  annuities, mutual funds and insurance products on an agency basis.  In
  September 1997, that corporation transferred its assets and liabilities to a
  newly formed North Carolina limited liability company, First Capital Services
  Company, LLC (the "LLC"), and the corporation was dissolved.  The Bank is the
  sole member of the LLC, and since the transfer of assets and liabilities the
  activities previously conducted by First Capital have been conducted by the
  LLC.  We earned $262,000 and $232,000 on a pre-tax basis from the activities
  of the LLC and First Capital during the years ended September 30, 1998 and
  1997, respectively.

  COMPETITION

       We face strong competition in originating real estate, commercial
  business and consumer loans and in attracting deposits.  We compete for real
  estate and other loans principally on the basis of interest rates, the types
  of loans we originate, the deposit products we offer and the quality of
  services we provide to our customers.  We also compete by offering products
  which are tailored to the local community.  Our competition in originating
  real estate loans comes primarily from other savings institutions, commercial
  banks, mortgage bankers and mortgage brokers.  Commercial 

                                       71
<PAGE>
 
  banks, credit unions and finance companies provide vigorous competition in
  consumer lending. Competition may increase as a result of the continuing
  reduction of restrictions on the interstate operations of financial
  institutions.

       We attract our deposits through our branch offices primarily from the
  local communities.  Consequently, competition for deposits is principally from
  other savings institutions, commercial banks, credit unions and brokers in our
  primary market area.  We compete for deposits and loans by offering what we
  believe to be a variety of deposit accounts at competitive rates, convenient
  business hours, a commitment to outstanding customer service and a well-
  trained staff. We believe we have developed strong relationships with local
  realtors and the community in general.

       We consider our primary market area for gathering deposits and
  originating loans to be Alamance County in north central North Carolina, which
  is the county in which our offices are located.  Based on data provided by a
  private marketing firm, we estimate that at June 30, 1997, we had 15.2% of
  deposits held by all banks and savings institutions in our market area.

  OFFICES AND OTHER MATERIAL PROPERTIES

       The following table sets forth the location and certain additional
  information regarding our offices at September 30, 1998.
                                        
<TABLE> 
<CAPTION> 

                                             Book Value at                    Deposits at
                          Year   Owned or     September 30,     Approximate   September 30,
                         Opened  Leased         1998 (1)      Square Footage    1998
                         ------  ------    ----------------   --------------  --------------
                                        (Dollars in thousands)
<S>                      <C>     <C>       <C>               <C>              <C>
MAIN OFFICE:
445 S. Main Street       1988    Owned       $3,839              33,700         $101,149
Burlington, NC  27215
 
BRANCH OFFICES:
2294 N. Church Street    1984    Leased(2)      277               2,600           24,520
Burlington, NC  27215
 
503 Huffman Mill Road    1982    Owned          348               2,600           42,614
Burlington, NC  27215
 
102 S. 5th Street        1973    Owned           55               2,000           22,573
Mebane, NC  27302
 
221 N. Main Street       1974    Owned          110               2,700           32,226
Graham, NC  27253

3466 S. Church Street    1996    Owned        1,451               4,000           12,612
Burlington, NC  27215
</TABLE>
__________
(1) Land and building only.
(2) Land is leased. Lease expires on July 5, 2009, with options to extend for
    three five-year periods.

       The book value of our investment in premises and equipment was $7.5
  million at September 30, 1998.  See Note 6 of Notes to Consolidated Financial
  Statements.

  EMPLOYEES

       As of September 30, 1998, we had 68 full-time and 11 part-time employees,
  none of whom were represented by a collective bargaining agreement.  We
  believe that our relationship with our employees is good.

                                       72
<PAGE>
 
  LEGAL PROCEEDINGS

       From time to time, we are a party to various legal proceedings incident
  to its business.  There currently are no legal proceedings to which we are a
  party, or to which any of our property was subject, which were expected to
  result in a material loss.  There are no pending regulatory proceedings to
  which we are a party or to which any of our properties is subject which are
  expected to result in a material loss.

                                    REGULATION

  DEPOSITORY INSTITUTION REGULATION

       General.  We are a North Carolina-chartered savings bank and a member of
  the FHLB of Atlanta and our deposits are insured by the FDIC through the SAIF.
  As a North Carolina savings bank, we are subject to regulation and supervision
  by the Administrator and the FDIC and to North Carolina and FDIC regulations
  governing such matters as capital standards, mergers, establishment of branch
  offices, subsidiary investments and activities and general investment
  authority.  The Administrator and the FDIC periodically examine us for
  compliance with various regulatory requirements and for safe and sound
  operations.  The FDIC also has the authority to conduct special examinations
  of us because our deposits are insured by the SAIF.  We must file reports with
  the Administrator describing our activities and financial condition and must
  obtain the approval from the Administrator and the FDIC prior to entering into
  certain transactions, such as mergers with, or acquisitions of, other
  depository institutions.

       Upon consummation of the Bank Conversion, the Converted Bank will be a
  North Carolina commercial bank and its deposit accounts will continue to be
  insured by the SAIF.  The Converted Bank will be subject to supervision,
  examination and regulation by the Commissioner (rather than the Administrator)
  and the FDIC and to North Carolina and federal statutory and regulatory
  provisions governing such matters as capital standards, mergers, subsidiary
  investments and establishment of branch offices, and it will remain subject to
  the FDIC's authority to conduct special examinations.  The Converted Bank will
  be required to file reports with the Commissioner and the FDIC concerning its
  activities and financial condition and will be required to obtain regulatory
  approvals prior to entering into certain transactions, including mergers with,
  or acquisitions of, other depository institutions.

       As a federally insured depository institution, we are and the Converted
  Bank will be, subject to various regulations promulgated by the Federal
  Reserve Board, including Regulation B (Equal Credit Opportunity), Regulation D
  (Reserve Requirements), Regulations E (Electronic Fund Transfers), Regulation
  Z (Truth in Lending), Regulation CC (Availability of Funds and Collection of
  Checks) and Regulation DD (Truth in Savings).

       The system of regulation and supervision applicable to us and the
  Converted Bank establishes a comprehensive framework for our operations and
  those of the Converted Bank and is intended primarily for the protection of
  the FDIC and the depositors of the Bank and the Converted Bank.  Changes in
  the regulatory framework could have a material effect on us, the Converted
  Bank and our respective operations that in turn, could have a material effect
  on the Company.

       Proposed Legislative and Regulatory Changes.  On May 13, 1998, the U.S.
  House of Representatives passed H.R. 10 (the "Act"), the Financial Services
  Competition Act of 1998, "which calls for a sweeping modernization of the
  banking system that would permit affiliations between commercial banks,
  securities firms, insurance companies and, subject to certain limitations,
  other commercial enterprises.  The stated purposes of the Act are to enhance
  consumer choice in the financial services marketplace, level the playing field
  among providers of financial services and increase competition.  H.R. 10
  removes the restrictions contained in the Glass-Steagall Act of 1933 and the
  Bank Holding Company Act of 1956, thereby allowing qualified financial holding
  companies to control banks, securities firms, insurance companies, and other
  financial firms.  Conversely, securities firms, insurance companies and
  financial firms would be allowed to own or affiliate with a commercial bank.
  Under the new framework, the Federal Reserve would 

                                       73
<PAGE>
 
  serve as an umbrella regulator to oversee the new financial holding company
  structure. Securities affiliates would be required to comply with all
  applicable federal securities laws, including registration and other
  requirements applicable to broker-dealers. The Act also provides the insurance
  affiliates be subject to applicable state insurance regulations and
  supervision. The Act preserves the thrift charter and all existing thrift
  powers, but restricts the activities of new unitary thrift holding companies.

       At the adjournment of Congress in October 1998, the Senate had not voted
  on the legislation and the Act had been returned to the Senate Banking
  Committee for further review  A bill similar to the Act was introduced for
  consideration by Congress when it reconvenes in 1999.  At this time, it is
  unknown whether the Act will be enacted, or if enacted, what form the final
  version of such legislation might take.

       Capital Requirements.  The Federal Reserve Board and the FDIC have
  established guidelines with respect to the maintenance of appropriate levels
  of capital by bank holding companies with consolidated assets of $150 million
  or more and state non-member banks, respectively.  The regulations impose two
  sets of capital adequacy requirements:  minimum leverage rules, which require
  bank holding companies and state non-member banks to maintain a specified
  minimum ratio of capital to total assets, and risk-based capital rules, which
  require the maintenance of specified minimum ratios of capital to "risk-
  weighted" assets.  The regulations of the FDIC and the Federal Reserve Board
  require bank holding companies and state non-member banks, respectively, to
  maintain a minimum leverage ratio of "Tier 1 capital" to total assets of 3%.
  Tier 1 capital is the sum of common stockholders' equity, certain perpetual
  preferred stock (which must be noncumulative with respect to banks), including
  any related surplus, and minority interests in consolidated subsidiaries;
  minus all intangible assets (other than certain purchased mortgage servicing
  rights and purchased credit card receivables), identified losses and
  investments in certain subsidiaries.  As a SAIF-insured, state-chartered bank,
  the Bank must also deduct from Tier 1 capital an amount equal to its
  investments in, and extensions of credit to, subsidiaries engaged in
  activities that are not permissible for national banks, other than debt and
  equity investments in subsidiaries engaged in activities undertaken as agent
  for customers or in mortgage banking activities or in subsidiary depository
  institutions or their holding companies.  Although setting a minimum 3%
  leverage ratio, the capital regulations state that only the strongest bank
  holding companies and banks, with composite examination ratings of 1 under the
  rating system used by the federal bank regulators, would be permitted to
  operate at or near such minimum level of capital.  All other bank holding
  companies and banks are expected to maintain a leverage ratio of at least 1%
  to 2% above the minimum ratio, depending on the assessment of an individual
  organization's capital adequacy by its primary regulator.  Any bank or bank
  holding companies experiencing or anticipating significant growth would be
  expected to maintain capital well above the minimum levels.  In addition, the
  Federal Reserve Board has indicated that whenever appropriate, and in
  particular when a bank holding company is undertaking expansion, seeking to
  engage in new activities or otherwise facing unusual or abnormal risks, it
  will consider, on a case-by-case basis, the level of an organization's ratio
  of tangible Tier 1 capital to total assets in making an overall assessment of
  capital.

       In addition to the leverage ratio, the regulations of the Federal Reserve
  Board and the FDIC require bank holding companies and state-chartered
  nonmember banks to maintain a minimum ratio of qualifying total capital to
  risk-weighted assets of at least 8% of which at least 4% must be Tier 1
  capital.  Qualifying total capital consists of Tier 1 capital plus Tier 2 or
  "supplementary" capital items which include allowances for loan losses in an
  amount of up to 1.25% of risk-weighted assets, cumulative preferred stock and
  preferred stock with a maturity of 20 years or more, certain other capital
  instruments and net unrealized gains on equity securities.  The includible
  amount of Tier 2 capital cannot exceed the institution's Tier 1 capital.
  Qualifying total capital is further reduced by the amount of the bank's
  investments in banking and finance subsidiaries that are not consolidated for
  regulatory capital purposes, reciprocal cross-holdings of capital securities
  issued by other banks and certain other deductions.  The risk-based capital
  regulations assign balance sheet assets and the credit equivalent amounts of
  certain off-balance sheet items to one of four broad risk weight categories.
  The aggregate dollar amount of each category is multiplied by the risk weight
  assigned to that category based principally on the degree of credit risk
  associated with the obligor.  The sum of these weighted values equals the bank
  holding company or the bank's risk-weighted assets.

                                       74
<PAGE>
 
       The federal bank regulators, including the Federal Reserve Board and the
  FDIC, have revised their risk-based capital requirements to ensure that such
  requirements provide for explicit consideration of interest rate risk.  Under
  the rule, a bank's interest rate risk exposure would be quantified using
  either the measurement system set forth in the rule or the bank's internal
  model for measuring such exposure, if such model is determined to be adequate
  by the bank's examiner.  If the dollar amount of a bank's interest rate risk
  exposure, as measured under either measurement system, exceeds 1% of the
  bank's total assets, the bank would be required under the rule to hold
  additional capital equal to the dollar amount of the excess.  Management of
  the Bank believes that interest rate risk component does not have a material
  effect on the Bank's capital.  Further, the FDIC has adopted a regulation that
  provides that the FDIC may take into account whether a bank has significant
  risks from concentrations of credit or non-traditional activities in
  determining the adequacy of its capital.  The Bank has not been advised that
  it will be required to maintain any additional capital under this regulation.
  The interest rate risk component does not apply to bank holding companies on a
  consolidated basis.

       In addition to FDIC regulatory capital requirements, the Administrator
  requires that net worth equal at least 5% of total assets.  Intangible assets
  must be deducted from net worth and assets when computing compliance with this
  requirement.

       At September 30, 1998, the Bank complied with each of the capital
  requirements of the FDIC and the Administrator.  For a description of the
  Bank's required and actual capital levels on September 30, 1998, see
  "Historical and Pro Forma Regulatory Capital Compliance."

       Following the Bank Conversion, the Converted Bank will be subject to the
  Commissioner's capital surplus regulation which requires commercial banks to
  maintain a capital surplus of at least 50% of common capital.  Common capital
  is defined as the total of the par value of shares times the number of shares
  outstanding.

       Prompt Corrective Regulatory Action.  Under the Federal Deposit Insurance
  Corporation Improvement Act of 1991 ("FDICIA"), the federal banking regulators
  are required to take prompt corrective action if an insured depository
  institution fails to satisfy certain minimum capital requirements.  All
  institutions, regardless of their capital levels, are restricted from making
  any capital distribution or paying any management fees if the institution
  would thereafter fail to satisfy the minimum levels for any of its capital
  requirements.  An institution that fails to meet the minimum level for any
  relevant capital measure (an "undercapitalized institution") may be: (i)
  subject to increased monitoring by the appropriate federal banking regulator;
  (ii) required to submit an acceptable capital restoration plan within 45 days;
  (iii) subject to asset growth limits; and (iv) required to obtain prior
  regulatory approval for acquisitions, branching and new lines of businesses.
  A "significantly undercapitalized" institution may be subject to statutory
  demands for recapitalization, broader application of restrictions on
  transactions with affiliates, limitations on interest rates paid on deposits,
  asset growth and other activities, possible replacement of directors and
  officers, and restrictions on capital distributions by any bank holding
  company controlling the institution.  Any company controlling the institution
  could also be required to divest the institution or the institution could be
  required to divest subsidiaries.  The senior executive officers of a
  significantly undercapitalized institution may not receive bonuses or
  increases in compensation without prior regulatory approval and the
  institution is prohibited from making payments of principal or interest on its
  subordinated debt.  If an institution's ratio of tangible capital to total
  assets falls below a "critical capital level," the institution will be subject
  to conservatorship or receivership within 90 days unless periodic
  determinations are made that forbearance from such action would better protect
  the deposit insurance fund.

       Federal banking regulators have adopted regulations implementing the
  prompt corrective action provisions of FDICIA.  Under these regulations, the
  federal banking regulators will generally measure a depository institution's
  capital adequacy on the basis of the institution's total risk-based capital
  ratio (the ratio of its total capital to risk-weighted assets), Tier 1 risk-
  based capital ratio (the ratio of its core capital to risk-weighted assets)
  and leverage ratio (the ratio of its core capital to adjusted total assets).
  Under the regulations, an institution that is not subject to an order or
  written directive by its primary federal regulator to meet or maintain a
  specific capital level will be deemed "well capitalized" if it also has: (i) a
  total risk-based capital ratio of 10% or greater; (ii) a Tier 1 risk-based
  capital ratio of 6% or greater; 

                                       75
<PAGE>
 
  and (iii) a leverage ratio of 5% or greater. An "adequately capitalized"
  depository institution is an institution that does not meet the definition of
  well capitalized and has: (i) a total risk-based capital ratio of 8% or
  greater; (ii) a Tier 1 risk-based capital ratio of 4% or greater; and (iii) a
  leverage ratio of 4% or greater (or 3% or greater if the depository
  institution has a composite 1 CAMELS rating). An "undercapitalized
  institution" is a depository institution that has (i) a total risk-based
  capital ratio less than 8%; or (ii) a Tier 1 risk-based capital ratio of less
  than 4%; or (iii) a leverage ratio of less than 4% (or less than 3% if the
  institution has a composite 1 CAMELS rating). A "significantly
  undercapitalized" institution is defined as a depository institution that has:
  (i) a total risk-based capital ratio of less than 6%; or (ii) a Tier 1 risk-
  based capital ratio of less than 3%; or (iii) a leverage ratio of less than
  3%. A "critically undercapitalized" institution is defined as a depository
  institution that has a ratio of "tangible equity" to total assets of less than
  2%. Tangible equity is defined as core capital plus cumulative perpetual
  preferred stock (and related surplus) less all intangibles other than
  qualifying supervisory goodwill and certain purchased mortgage servicing
  rights. The appropriate federal banking agency may reclassify a well
  capitalized depository institution as adequately capitalized and may require
  an adequately capitalized or undercapitalized institution to comply with the
  supervisory actions applicable to institutions in the next lower capital
  category (but may not reclassify a significantly undercapitalized institution
  as critically under-capitalized) if it determines, after notice and an
  opportunity for a hearing, that the institution is in an unsafe or unsound
  condition or that the institution has received and not corrected a less-than-
  satisfactory rating for any CAMELS rating category. At September 30, 1998, the
  Bank was classified as "well capitalized" under FDIC regulations, and
  management of the Bank believes that the Converted Bank will, immediately
  after the Conversion, also be classified as "well-capitalized."

       Safety and Soundness Guidelines.  Under FDICIA, as amended by the Riegle
  Community Development and Regulatory Improvement Act of 1994 (the "CDRI Act"),
  each federal banking agency was required to establish safety and soundness
  standards for institutions under its authority.  The interagency guidelines
  require depository institutions to maintain internal controls and information
  systems and internal audit systems that are appropriate for the size, nature
  and scope of the institution's business.  The guidelines also establish
  certain basic standards for loan documentation, credit underwriting, interest
  rate risk exposure, and asset growth.  The guidelines further provide that
  depository institutions should maintain safeguards to prevent the payment of
  compensation, fees and benefits that are excessive or that could lead to
  material financial loss, and should take into account factors such as
  comparable compensation practices at comparable institutions.  If the
  appropriate federal banking agency determines that a depository institution is
  not in compliance with the safety and soundness guidelines, it may require the
  institution to submit an acceptable plan to achieve compliance with the
  guidelines.  A depository institution must submit an acceptable compliance
  plan to its primary federal regulator within 30 days of receipt of a request
  for such a plan.  Failure to submit or implement a compliance plan may subject
  the institution to regulatory sanctions.  Management believes that the Bank
  meets all the standards adopted in the interagency guidelines.

       Community Reinvestment Act.  The Bank, like other financial institutions,
  is subject to the Community Reinvestment Act ("CRA").  The purpose of the CRA
  is to encourage financial institutions to help meet the credit needs of their
  entire communities, including the needs of low- and moderate-income
  neighborhoods.  During the Bank's last compliance examination, the Bank
  received a "satisfactory" rating with respect to CRA compliance.  The Bank's
  rating with respect to CRA compliance would be a factor to be considered by
  the Federal Reserve Board and the FDIC in considering applications submitted
  by the Bank to acquire branches or to acquire or combine with other financial
  institutions and take other actions and, if such rating was less than
  "satisfactory," could result in the denial of such applications.

       The federal banking regulatory agencies have implemented an evaluation
  system that rates institutions based on their actual performance in meeting
  community credit needs.  Under the regulations, a bank will first be evaluated
  and rated under three categories: a lending test, an investment test and a
  service test.  For each of these three tests, the savings bank will be given a
  rating of either "outstanding," "high satisfactory," "low satisfactory,"
  "needs to improve," or "substantial non-compliance."  A set of criteria for
  each rating has been developed and is included in the regulation.  If an
  institution disagrees with a particular rating, the institution has the burden
  of rebutting the presumption by clearly establishing that the quantitative
  measures do not accurately present its actual performance, or that
  demographics, 

                                       76
<PAGE>
 
  competitive conditions or economic or legal limitations peculiar to its
  service area should be considered. The ratings received under the three tests
  will be used to determine the overall composite CRA rating. The composite
  ratings will be the same as those that are currently given: "outstanding,"
  "satisfactory," "needs to improve" or "substantial non-compliance."

       Federal Home Loan Bank System.  The FHLB System consists of 12 district
  FHLBs subject to supervision and regulation by the Federal Housing Finance
  Board ("FHFB").  The FHLBs provide a central credit facility primarily for
  member institutions.  As a member of the FHLB of Atlanta, the Bank is required
  to acquire and hold shares of capital stock in the FHLB of Atlanta in an
  amount at least equal to 1% of the aggregate unpaid principal of its home
  mortgage loans, home purchase contracts, and similar obligations at the
  beginning of each year, or 1/20 of its advances (borrowings) from the FHLB of
  Atlanta, whichever is greater.  The Bank was in compliance with this
  requirement with investment in FHLB of Atlanta stock at September 30, 1998 of
  $1.3 million.  The FHLB of Atlanta serves as a reserve or central bank for its
  member institutions within its assigned district.  It is funded primarily from
  proceeds derived from the sale of consolidated obligations of the FHLB System.
  It offers advances to members in accordance with policies and procedures
  established by the FHFB and the Board of Directors of the FHLB of Atlanta.
  Long-term advances may only be made for the purpose of providing funds for
  residential housing finance.  At September 30, 1998, the Bank had $20.0
  million in advances outstanding from the FHLB of Atlanta.  Upon completion of
  the Bank Conversion, the Converted Bank will continue to be a member of the
  FHLB of Atlanta.

       Reserves.  Pursuant to regulations of the Federal Reserve Board, the Bank
  must maintain average daily reserves against their transaction accounts.
  Reserves equal to 3% must be maintained on the first $47.8 million of
  transaction accounts, plus 10% on the remainder.  This percentage is subject
  to adjustment by the Federal Reserve Board.  Because required reserves must be
  maintained in the form of vault cash or in a non-interest bearing account at a
  Federal Reserve Bank, the effect of the reserve requirement is to reduce the
  amount of the institution's interest-earning assets.  As of September 30,
  1998, the Bank met its reserve requirements.

       Upon consummation of the Bank Conversion, the Converted Bank will be
  subject to the reserve requirements of North Carolina commercial banks.  North
  Carolina law requires state non-member banks to maintain, at all times, a
  reserve fund in an amount set by regulation of the Commission.

       Deposit Insurance.  The Bank is required to pay assessments based on a
  percentage of its insured deposits to the FDIC for insurance of its deposits
  by the SAIF.  Under the FDIC's risk-based deposit insurance assessment system,
  the assessment rate for an insured depository institution depends on the
  assessment risk classification assigned to the institution by the FDIC, which
  is determined by the institution's capital level and supervisory evaluations.
  Based on the data reported to regulators for the date closest to the last day
  of the seventh month preceding the semi-annual assessment period, institutions
  are assigned to one of three capital groups -- well capitalized, adequately
  capitalized or undercapitalized -- using the same percentage criteria as in
  the prompt corrective action regulations.  See "-- Prompt Corrective
  Regulatory Action."  Within each capital group, institutions are assigned to
  one of three subgroups on the basis of supervisory evaluations by the
  institution's primary supervisory authority and such other information as the
  FDIC determines to be relevant to the institution's financial condition and
  the risk posed to the deposit insurance fund.  Subgroup A consists of
  financially sound institutions with only a few minor weaknesses.  Subgroup B
  consists of institutions that demonstrate weaknesses which, if not corrected,
  could result in significant deterioration of the institution and increased
  risk of loss to the deposit insurance fund.  Subgroup C consists of
  institutions that pose a substantial probability of loss to the deposit
  insurance fund unless effective corrective action is taken.  In 1996, the FDIC
  imposed a one-time assessment of 65.7 basis points of insured deposits as of
  March 31, 1995, that fully capitalized the SAIF and had the effect of reducing
  future SAIF assessments.  Accordingly, although the special assessment
  resulted in a one-time charge to the Bank of approximately $1.3 million pre-
  tax, the recapitalization of the SAIF had the effect of reducing the Bank's
  and the Converted Bank's future deposit insurance premiums to the SAIF.  Both
  BIF and SAIF members are assessed an amount for the Financing Corporation Bond
  payments.  BIF members are assessed approximately 1.3 basis points while the
  SAIF rate is approximately 6.4 basis points until January 1, 2000.  At that
  time, BIF and SAIF members will begin pro rata sharing of the payment at an
  expected rate of 2.43 basis points.

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<PAGE>
 
       Although the Converted Bank, as a North Carolina commercial bank, would
  qualify for insurance of deposits by the BIF, substantial entrance and exit
  fees apply to conversions from SAIF to BIF insurance.  Accordingly, following
  the Bank Conversion, the Converted Bank will remain a member of the SAIF,
  which will insure the deposits of the Converted Bank to a maximum of $100,000
  for each depositor.  Because the Converted Bank will continue to be a SAIF
  member, its deposit insurance assessments will be determined on the same basis
  as the deposit insurance assessments paid by the Bank.

       Liquidity Requirements.  FDIC policy requires that banks maintain an
  average daily balance of liquid assets (cash, certain time deposits, bankers'
  acceptances and specified United States government, state, or federal agency
  obligations) in an amount which it deems adequate to protect safety and
  soundness of the bank.  The FDIC currently has no specific level which it
  requires.

       The Bank also is subject to the Administrator's requirement that the
  ratio of liquid assets to total assets equal at least 10%.  The computation of
  liquidity under North Carolina regulations allows the inclusion of mortgage-
  backed securities and investments which, in the judgment of the Administrator,
  have a readily ascertainable market value, including investments with
  maturities in excess of five years.  At September 30, 1998, the Bank's
  liquidity ratio exceeded the North Carolina regulations.

       Dividend Restrictions.  Under FDIC regulations, the Bank is prohibited
  from making any capital distributions if after making the distribution, the
  Bank would have: (i) a total risk-based capital ratio of less than 8%; (ii) a
  Tier 1 risk-based capital ratio of less than 4%; or (iii) a leverage ratio of
  less than 4%.

       Earnings of the Bank appropriated to bad debt reserves and deducted for
  Federal income tax purposes are not available for payment of cash dividends or
  other distributions to stockholders without payment of taxes at the then
  current tax rate by the Bank on the amount of earnings removed from the pre-
  1988 reserves for such distributions.  The Bank intends to make full use of
  this favorable tax treatment and does not contemplate use of any earnings in a
  manner which would create federal tax liabilities.

       The Bank may not pay dividends on its capital stock if its regulatory
  capital would thereby be reduced below the amount then required for the
  liquidation account established for the benefit of certain depositors of the
  Bank at the time of the Stock Conversion.

       The Company is subject to limitations on dividends imposed by the Federal
  Reserve Board.  See "-- Regulation of the Company Following the Bank
  Conversion -- Dividends."

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

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<PAGE>
 
       State non-member banks also are subject to the restrictions contained in
  Section 22(h) of the Federal Reserve Act and the Federal Reserve Board's
  Regulation O thereunder on loans to executive officers, directors and
  principal stockholders.  Under Section 22(h), loans to a director, executive
  officer and to a greater than 10% stockholder of a state non-member bank and
  certain affiliated interests of such persons, may not exceed, together with
  all other outstanding loans to such person and affiliated interests, the
  institution's loans-to-one-borrower limit and all loans to such persons may
  not exceed the institution's unimpaired capital and unimpaired surplus.
  Section 22(h) also prohibits loans, above amounts prescribed by the
  appropriate federal banking agency, to directors, executive officers and
  greater than 10% stockholders of a savings institution, and their respective
  affiliates, unless such loan is approved in advance by a majority of the board
  of directors of the institution with any "interested" director not
  participating in the voting.  Regulation O prescribes the loan amount (which
  includes all other outstanding loans to such person) as to which such prior
  board of director approval is required as being the greater of $25,000 or 5%
  of capital and surplus (up to $500,000).  Further, Section 22(h) requires that
  loans to directors, executive officers and principal stockholders be made on
  terms substantially the same as offered in comparable transactions to other
  persons.  Section 22(h) also generally prohibits a depository institution from
  paying the overdrafts of any of its executive officers or directors.

       State non-member banks also are subject to the requirements and
  restrictions of Section 22(g) of the Federal Reserve Act on loans to executive
  officers and the restrictions of 12 U.S.C. (S)1972 on certain tying
  arrangements and extensions of credit by correspondent banks. Section 22(g) of
  the Federal Reserve Act requires loans to executive officers of depository
  institutions not be made on terms more favorable than those afforded to other
  borrowers, requires approval by the board of directors of a depository
  institution for extension of credit to executive officers of the institution,
  and imposes reporting requirements for and additional restrictions on the
  type, amount and terms of credits to such officers.  Section 1972 (i)
  prohibits a depository institution from extending credit to or offering any
  other services, or fixing or varying the consideration for such extension of
  credit or service, on the condition that the customer obtain some additional
  service from the institution or certain of its affiliates or not obtain
  services of a competitor of the institution, subject to certain exceptions,
  and (ii) prohibits extensions of credit to executive officers, directors, and
  greater than 10% stockholders of a depository institution by any other
  institution which has a correspondent banking relationship with the
  institution, unless such extension of credit is on substantially the same
  terms as those prevailing at the time for comparable transactions with other
  persons and does not involve more than the normal risk of repayment or present
  other unfavorable features.

       Restrictions on Certain Activities.  Under FDICIA, state-chartered banks
  with deposits insured by the FDIC are generally prohibited from acquiring or
  retaining any equity investment of a type or in an amount that is not
  permissible for a national bank.  The foregoing limitation, however, does not
  prohibit FDIC-insured state banks from acquiring or retaining an equity
  investment in a subsidiary in which the bank is a majority owner.  State-
  chartered banks are also prohibited from engaging as principal in any type of
  activity that is not permissible for a national bank and subsidiaries of
  state-chartered, FDIC-insured state banks may not engage as principal in any
  type of activity that is not permissible for a subsidiary of a national bank
  unless in either case the FDIC determines that the activity would pose no
  significant risk to the appropriate deposit insurance fund and the bank is,
  and continues to be, in compliance with applicable capital standards.

       The FDIC has adopted regulations to clarify the foregoing restrictions on
  activities of FDIC-insured state-chartered banks and their subsidiaries.
  Under the regulations, the term activity refers to the authorized conduct of
  business by an insured state bank and includes acquiring or retaining any
  investment other than an equity investment.  An activity permissible for a
  national bank includes any activity expressly authorized for national banks by
  statute or recognized as permissible in regulations, official circulars or
  bulletins or in any order or written interpretation issued by the Office of
  the Comptroller of the Currency ("OCC").  In its regulations, the FDIC
  indicates that it will not permit state banks to directly engage in commercial
  ventures or directly or indirectly engage in any insurance underwriting
  activity other than to the extent such activities are permissible for a
  national bank or a national bank subsidiary or except for certain other
  limited forms of insurance underwriting permitted under the regulations.
  Under the regulations, the FDIC permits state banks that meet applicable
  minimum capital requirements to engage as principal in certain activities that
  are not permissible to national banks including guaranteeing obligations of
  others, activities which the Federal 

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<PAGE>
 
  Reserve Board has found by regulation or order to be closely related to
  banking and certain securities activities conducted through subsidiaries.

       Subject to limitation by the Administrator, North Carolina-chartered
  savings banks may make any loan or investment or engage in any activity which
  is permitted to federally chartered institutions.  However, a North Carolina-
  chartered savings bank cannot invest more than 15% of its total assets in
  business, commercial, corporate and agricultural loans.  In addition to such
  lending authority, North Carolina-chartered savings banks are authorized to
  invest funds, in excess of loan demand, in certain statutorily permitted
  investments, including but not limited to (i) obligations of the United
  States, or those guaranteed by it; (ii) obligations of the State of North
  Carolina; (iii) bank demand or time deposits; (iv) stock or obligations of the
  federal deposit insurance fund or a FHLB; (v) savings accounts of any savings
  institution as approved by the board of directors; and (vi) stock or
  obligations of any agency of the State of North Carolina or of the United
  States or of any corporation doing business in North Carolina whose principal
  business is to make education loans.

  REGULATION OF THE COMPANY FOLLOWING THE BANK CONVERSION

       General.  Upon consummation of the Bank Conversion, the Company, as the
  sole shareholder of the Converted Bank, will become a bank holding company and
  will register as such with the Federal Reserve Board.  Bank holding companies
  are subject to comprehensive regulation by the Federal Reserve Board under the
  Bank Holding Company Act of 1956, as amended (the "BHCA"), and the regulations
  of the Federal Reserve Board.  As a bank holding company, the Company will be
  required to file with the Federal Reserve Board annual reports and such
  additional information as the Federal Reserve Board may require, and will be
  subject to regular examinations by the Federal Reserve Board.  The Federal
  Reserve Board also has extensive enforcement authority over bank holding
  companies, including, among other things, the ability to assess civil money
  penalties, to issue cease and desist or removal orders and to require that a
  holding company divest subsidiaries (including its bank subsidiaries).  In
  general, enforcement actions may be initiated for violations of law and
  regulations and unsafe or unsound practices.

       Under the BHCA, a bank holding company must obtain Federal Reserve Board
  approval before: (i) acquiring, directly or indirectly, ownership or control
  of any voting shares of another bank or bank holding company if, after such
  acquisition, it would own or control more than 5% of such shares (unless it
  already owns or controls the majority of such shares); (ii) acquiring all or
  substantially all of the assets of another bank or bank holding company; or
  (iii) merging or consolidating with another bank holding company.
  Satisfactory financial condition, particularly with respect to capital
  adequacy, and a satisfactory CRA rating generally are prerequisites to
  obtaining federal regulatory approval to make acquisitions.

       The BHCA also prohibits a bank holding company, with certain exceptions,
  from acquiring direct or indirect ownership or control of more than 5% of the
  voting shares of any company which is not a bank or bank holding company, or
  from engaging directly or indirectly in activities other than those of
  banking, managing or controlling banks, or providing services for its
  subsidiaries.  The principal exceptions to these prohibitions involve certain
  non bank activities which, by statute or by Federal Reserve Board regulation
  or order, have been identified as activities closely related to the business
  of banking or managing or controlling banks.  The list of activities permitted
  by the Federal Reserve Board includes, among other things, operating a savings
  institution, mortgage company, finance company, credit card company or
  factoring company; performing certain data processing operations; providing
  certain investment and financial advice; underwriting and acting as an
  insurance agent for certain types of credit-related insurance; leasing
  property on a full-payout, non-operating basis; selling money orders,
  travelers' checks and United States Savings Bonds; real estate and personal
  property appraising; providing tax planning and preparation services; and,
  subject to certain limitations, providing securities brokerage services for
  customers.  The Company has no present plans to engage in any of these
  activities.

       Under the BHCA, any company must obtain approval of the Federal Reserve
  Board prior to acquiring control of the Company or the Converted Bank.  For
  purposes of the BHCA, "control" is defined as ownership of more than

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<PAGE>
 
  25% of any class of voting securities of the Company or the Bank, the ability
  to control the election of a majority of the directors, or the exercise of a
  controlling influence over management or policies of the Company or the Bank.
  In addition, the Change in Bank Control Act and the related regulations of the
  Federal Reserve Board require any person or persons acting in concert (except
  for companies required to make application under the BHCA), to file a written
  notice with the Federal Reserve Board before such person or persons may
  acquire control of the Company or the Converted Bank. The Change in Bank
  Control Act defines "control" as the power, directly or indirectly, to vote
  25% or more of any voting securities or to direct the management or policies
  of a bank holding company or an insured bank.

       The Federal Reserve Board has adopted guidelines regarding the capital
  adequacy of bank holding companies, which require bank holding companies to
  maintain specified minimum ratios of capital to total assets and capital to
  risk-weighted assets.  See " -- Depository Institution Regulation -- Capital
  Requirements."

       Interstate Banking.  The Riegle-Neal Interstate Banking and Branching
  Efficiency Act of 1994 (the "Reigle-Neal Act") was enacted to ease
  restrictions on interstate banking.  Effective September 29, 1995, the Act
  allows the Federal Reserve Board to approve an application of an adequately
  capitalized and adequately managed bank holding company to acquire control of,
  or acquire all or substantially all of the assets of, a bank located in a
  state other than such holding company's home state, without regard to whether
  the transaction is prohibited by the laws of any state.  The Federal Reserve
  Board may not approve the acquisition of a bank that has not been in existence
  for a minimum of five years (regardless of a longer minimum period specified
  by the statutory law of the host state).  The Act also prohibits the Federal
  Reserve Board from approving an application if the applicant (and its
  depository institution affiliates) controls or would control more than 10% of
  the insured deposits in the United States or 30% or more of the deposits in
  the target bank's home state or in any state in which the target bank
  maintains a branch.  The Act does not affect the authority of states to limit
  the percentage of total insured deposits in the state which may be held or
  controlled by a bank or bank holding company to the extent such limitation
  does not discriminate against out-of-state banks or bank holding companies.
  Individual states may also waive the 30% statewide concentration limit
  contained in the Act.

       Additionally, The federal banking agencies are authorized to approve
  interstate merger transactions without regard to whether such transaction is
  prohibited by the law of any state, unless the home state of one of the banks
  opts out of the Act by adopting a law, which applies equally to all out-of-
  state banks and expressly prohibits merger transactions involving out-of-state
  banks, after the date of enactment of the Act and prior to June 1, 1997. North
  Carolina has enacted legislation permitting interstate banking transactions.
  Interstate acquisitions of branches will be permitted only if the law of the
  state in which the branch is located permits such acquisitions. Interstate
  mergers and branch acquisitions will also be subject to the nationwide and
  statewide insured deposit concentration amounts described above.

       The Act authorizes the FDIC to approve interstate branching de novo by
  state banks only in states which specifically allow for such branching.
  Pursuant to the Riegle-Neal Act, the appropriate federal banking agencies have
  adopted regulations which prohibit any out-of-state bank from using the
  interstate branching authority primarily for the purpose of deposit
  production.  These regulations include guidelines to ensure that interstate
  branches operated by an out-of-state bank in a host state are reasonably
  helping to meet the credit needs of the communities which they serve.

       Dividends.  The Federal Reserve Board has issued a policy statement on
  the payment of cash dividends by bank holding companies, which expresses the
  Federal Reserve Board's view that a bank holding company should pay cash
  dividends only to the extent that the company's net income for the past year
  is sufficient to cover both the cash dividends and a rate of earning retention
  that is consistent with the company's capital needs, asset quality and overall
  financial condition.  The Federal Reserve Board also indicated that it would
  be inappropriate for a company experiencing serious financial problems to
  borrow funds to pay dividends.  Furthermore, under the prompt corrective
  action regulations adopted by the Federal Reserve Board pursuant to FDICIA,
  the Federal Reserve Board may prohibit a bank holding company from paying any
  dividends if the holding company's bank subsidiary is classified as
  "undercapitalized".  See "-- Depository Institution Regulation -- Prompt
  Corrective Regulatory Action."

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<PAGE>
 
       Bank holding companies are required to give the Federal Reserve Board
  prior written notice of any purchase or redemption of its outstanding equity
  securities if the gross consideration for the purchase or redemption, when
  combined with the net consideration paid for all such purchases or redemptions
  during the preceding 12 months, is equal to 10% or more of the their
  consolidated retained earnings.  The Federal Reserve Board may disapprove such
  a purchase or redemption if it determines that the proposal would constitute
  an unsafe or unsound practice or would violate any law, regulation, Federal
  Reserve Board order, or any condition imposed by, or written agreement with,
  the Federal Reserve Board.  Bank holding companies whose capital ratios exceed
  the thresholds for "well-capitalized" banks on a consolidated basis are exempt
  from the foregoing requirement if they were rated composite 1 or 2 in their
  most recent inspection and are not the subject of any unresolved supervisory
  issues.

  FEDERAL SECURITIES LAW

       The Company has filed with the SEC a Registration Statement under the
  Securities Act of 1933, as amended (the "Securities Act"), for the
  registration of the common stock to be issued in the Stock Conversion.  Upon
  completion of the Stock Conversion, the common stock will be registered with
  the SEC under the Securities Exchange Act of 1934, as amended (the "Exchange
  Act").  The Company will then be subject to the information, proxy
  solicitation, insider trading restrictions and other requirements of the
  Exchange Act.

       The registration under the Securities Act of the common stock does not
  cover the resale of such shares.  Shares of the common stock purchased by
  persons who are not affiliates of the Company may be resold without
  registration.  Shares purchased by an affiliate of the Company will be subject
  to the resale restrictions of Rule 144 under the Securities Act.  If the
  Company meets the current public information requirements of Rule 144 under
  the Securities Act, each affiliate of the Company who complies with the other
  conditions of Rule 144 (including those that require the affiliate's sale to
  be aggregated with those of certain other persons) would be able to sell in
  the public market, without registration, a number of shares not to exceed, in
  any three-month period, the greater of (i) 1% of the outstanding shares of the
  Company or (ii) the average weekly volume of trading in such shares during the
  preceding four calendar weeks.  Provision may be made in the future by the
  Company to permit affiliates to have their shares registered for sale under
  the Securities Act under certain circumstances.  There are currently no demand
  registration rights outstanding.  However, in the event the Company at some
  future time determines to issue additional shares from its authorized but
  unissued shares, the Company might offer registration rights to certain of its
  affiliates who want to sell their shares.

                                   TAXATION

  GENERAL

       The Bank files a federal income tax return based on a fiscal year ending
  September 30.

  FEDERAL INCOME TAXATION

       Savings institutions such as the Bank are subject to the provisions of
  the Internal Revenue Code of 1986, as amended (the "Internal Revenue Code") in
  the same general manner as other corporations.  Through tax years beginning
  before December 31, 1995, institutions such as the Bank which met certain
  definitional tests and other conditions prescribed by the Internal Revenue
  Code benefitted from certain favorable provisions regarding their deductions
  from taxable income for annual additions to their bad debt reserve.  For
  purposes of the bad debt reserve deduction, loans are separated into
  "qualifying real property loans," which generally are loans secured by
  interests in certain real property, and "nonqualifying loans", which are all
  other loans.  The bad debt reserve deduction with respect to nonqualifying
  loans must be based on actual loss experience.  The amount of the bad debt
  reserve deduction with respect to qualifying real property loans may be based
  upon actual loss experience (the "experience method") or a percentage of
  taxable income determined without regard to such deduction (the "percentage of
  taxable income method").  Under the experience method, the bad debt deduction
  for an addition to the reserve for qualifying real property loans was an

                                       82
<PAGE>
 
  amount determined under a formula based generally on the bad debts actually
  sustained by a savings institution over a period of years.  Under the
  percentage of taxable income method, the bad debt reserve deduction for
  qualifying real property loans was computed as 8% of a savings institution's
  taxable income, with certain adjustments.  The Bank generally elected to use
  the method which has resulted in the greatest deductions for federal income
  tax purposes in any given year.

       Legislation that is effective for tax years beginning after December 31,
  1995 requires institutions to recapture into taxable income over a six taxable
  year period the portion of the tax loan reserve that exceeds the pre-1988 tax
  loan loss reserve.  As a result of changes in the law, saving institutions
  were required to change to either the reserve method or the specific charge-
  off method that applied to banks.

       The Bank is not required to provide a deferred tax liability for the tax
  effect of additions to the tax bad debt reserve through 1987, the base year.
  Retained income at September 30, 1998 includes approximately $4.2 million for
  which no provision for federal income tax has been made.  These amounts
  represent allocations of income to bad debt deductions for tax purposes only.
  Reduction of such amounts for purposes other than tax bad debt losses could
  create income for tax purposes in certain remote instances, which would be
  subject to the then current corporate income tax rate.

       The Bank's federal income tax returns have not been audited since 1993.

       For additional information, see "Management's Discussion and Analysis of
  Financial Condition and Results of Operations -- Impact of New Accounting
  Standards" and the financial statements and related notes appearing elsewhere
  herein.

  STATE INCOME TAXATION

       Under North Carolina law, the corporate income tax currently is 7.25% of
  federal taxable income as computed under the Internal Revenue Code, subject to
  certain prescribed adjustments.  This rate will be reduced to 7.00% for 1999
  and 6.9% for 2000 and thereafter.  In addition, for tax years beginning in
  1991, 1992, 1993 and 1994, corporate taxpayers were required to pay a surtax
  equal to 4%, 3%, 2% and 1%, respectively, of the state income tax otherwise
  payable.  An annual state franchise tax is imposed at a rate of .15% 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)
  appraised valuation of property in North Carolina.

       For additional information regarding taxation, see Notes 1 and 10 of the
  Notes to the Financial Statements.


                           MANAGEMENT OF THE COMPANY

       The Board of Directors of the Company consists of the same individuals
  who serve as directors of the Bank.  Their biographical information is set
  forth under "Management of the Bank -- Directors."  The Board of Directors of
  the Company is divided into three classes.  Directors of the Company will
  serve for three year terms or until their successors are elected and
  qualified, with approximately one-third of the directors being elected at each
  annual meeting of stockholders, beginning with the first annual meeting of
  stockholders following the Stock Conversion.  Directors Bean, McGill and
  Stadler have terms of office expiring at the 2000 annual meeting, Directors
  Barnwell, McClure and Quakenbush have terms of office expiring at the 2001
  annual meeting, and Directors Keziah and Shirley have terms of office expiring
  at the 2002 annual meeting.  Under the Company's bylaws, a person who is 75
  years of age  or older and who is not an employee of the Company or the Bank
  shall not be eligible for election, re-election, appointment, or re-
  appointment to the Board of Directors, and a non-employee director shall not
  serve beyond the annual meeting of the Company immediately following the non-
  employee director becoming 75.

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<PAGE>
 
       The following individuals hold the offices in the Company set forth below
  opposite their names.

       Name                      Title
       ----                      -----
       James C. McGill           President and Chief Executive Officer
       A. Christine Baker        Treasurer and Secretary
       Fairfax C. Reynolds       Vice President and Assistant Secretary

       The executive officers of the Company are elected annually and hold
  office until their respective successors have been elected and qualified or
  until death, resignation or removal by the Board of Directors of the Company.

       Since the formation of the Company, none of the executive officers,
  directors or other personnel have received remuneration from the Company.
  Information concerning the principal occupations and employment of the
  directors and executive officers of the Company during the past five years is
  set forth under "Management of the Bank -- Directors" and "-- Executive
  Officers Who Are Not Directors."  Executive officers and directors of the
  Company will be compensated as described below under "Management of the Bank."


                             MANAGEMENT OF THE BANK

  DIRECTORS

       Because we are a mutual savings bank, our members have elected our Board
  of Directors.  Upon completion of the Stock Conversion, the directors of the
  Bank immediately prior to the Stock Conversion will continue to serve as
  directors of the Converted Bank.  Currently, the term of each director is one
  year, and all of the members of the Board of Directors stand for election each
  year.  This will continue to be the case for the Converted Bank following the
  Bank Conversion.  Because the Company will own all the issued and outstanding
  capital stock of the Converted Bank following the Conversion, the Board of
  Directors of the Company will elect the directors of the Converted Bank.

       The following table sets forth certain information with respect to the
  individuals who serve currently as members of our Board of Directors.  There
  are no arrangements or understandings between the Bank and any director
  pursuant to which such person has been elected a director of the Bank, and no
  director is related to any other director or executive officer by blood,
  marriage or adoption.  All directors' terms expire in December 1999.


                               AGE AT
                            SEPTEMBER 30,
  NAME                            1998       DIRECTOR SINCE
  -----                     -------------    --------------
 
  James A. Barnwell, Jr.          58            1988
  Bernie C. Bean                  68            1978
  Richard C. Keziah               66            1983
  James G. McClure                53            1989
  James C. McGill                 57            1988
  T. Scott Quakenbush             67            1978
  Richard H. Shirley              51            1987
  Virgil L. Stadler               62            1982
 

                                       84
<PAGE>
 
       Presented below is certain information concerning the directors of the
  Bank.  Unless otherwise stated, all directors have held the positions
  indicated for at least the past five years.

       JAMES A. BARNWELL, JR. is president of Huffman Oil Co., Inc., a petroleum
  marketer in Burlington, North Carolina.  He has served on the advisory board
  of the Salvation Army Boys & Girls Club and the YMCA board.

       BERNIE C. BEAN is retired.  From 1988 to 1995 he was the national sales
  manager of Craftique, Inc., a furniture manufacturer located in Mebane, North
  Carolina.

       RICHARD C. KEZIAH is president of Monarch Hosiery Mills, Inc. in
  Burlington, North Carolina.  He also serves on the board of directors of Elon
  Homes for Children.

       JAMES G. MCCLURE is president of Green & McClure, a retail furniture
  store in Graham, North Carolina.  He has served as president of the Graham
  Area  Business Association, on the zoning board for the city of Graham and is
  an Elder at the Graham Presbyterian Church.

       JAMES C. MCGILL has been President and Chief Executive Officer of the
  Bank since December 1988.  He serves on the Boards of Hospice of Alamance and
  Alamance Community College and in 1997 served as the chairman of the North
  Carolina Bankers Association.

       T. SCOTT QUAKENBUSH retired in April 1997 from his position as vice
  president and sales manager with Carolina Paper Box Company in Burlington,
  North Carolina.

       RICHARD H. SHIRLEY is president of Dick Shirley Chevrolet, Inc., an
  automobile dealership located in Burlington, North Carolina.  He has served as
  the president of the Alamance County YMCA and as a member and chairman of the
  Economic Development Committee of the Burlington area Chamber of Commerce.

       VIRGIL L. STADLER is the vice president of Stadler Country Hams, Inc. in
  Elon College, North Carolina.  He is active with the ACC Foundation, Elon
  Homes for Children and the Burlington area Chamber of Commerce.

  EXECUTIVE OFFICERS WHO ARE NOT DIRECTORS

       The following sets forth information with respect to executive officers
  of the Bank who do not serve on the Board of Directors.
 
  <TABLE>
  <CAPTION>
                            AGE AT
                         SEPTEMBER 30,
  NAME                       1998             TITLE WITH THE BANK 
  ----                  -------------        ---------------------
  <S>                   <C>                  <C>
 
  A. Christine Baker       45                 Executive Vice President - Chief Financial Officer,
                                              Secretary and Treasurer
  Fairfax C. Reynolds      45                 Executive Vice President - Commercial and Retail
                                              Banking
  Frank Gavigan            40                 Senior Vice President - Senior Credit Officer
  John D. Hansell          61                 Manager - First Capital Services, LLC
 </TABLE>

       A. CHRISTINE BAKER has served as Executive Vice President, Secretary and
  Treasurer of the Bank since April 1985.  She has served as president and
  director of the Burlington Rotary Club, director and treasurer of the local
  chapter of the American Red Cross and director and vice president of the
  Childcare Resource and Referral Service.

                                       85
<PAGE>
 
       FAIRFAX C. REYNOLDS has served as Executive Vice President in charge of
  Retail and Commercial Banking of the Bank since 1989.  He serves on the Board
  of Directors of YMCA of Alamance County, the Alamance County Arts Council, the
  Alamance County Area Chamber of Commerce and the Alamance Country Club.  He is
  an Elder of the First Presbyterian Church.

       FRANK GAVIGAN has served as Senior Vice President - Senior Credit Officer
  of the Bank since 1990.  He has served as the budget director and on the
  executive committee of the United Way, as Vice President and a director of
  Alamance County Meals on Wheels, as President and a director of Alamance
  Prevention Alliance and on the finance committee of Front Street United
  Methodist Church.

       JOHN D. HANSELL has served since May 1987 as Manager of 1st Capital
  Services Company, LLC and its predecessor, First Capital Services, Inc.,
  entities owned by the Bank that sell annuities, mutual funds and insurance
  products on an agency basis.  He has served on the small business council of
  the Alamance Chamber of Commerce and on the board of directors of the
  International Association of Financial Planners.

  COMMITTEES OF THE BOARD OF DIRECTORS

       Our Board of Directors meets monthly and may have additional special
  meetings.  During the year ended September 30, 1998, the Board met 12 times.
  No director attended fewer than 75% in the aggregate of the total number of
  Board meetings held during the year ended September 30, 1998 and the total
  number of meetings held by committees on which he served during such fiscal
  year.  The Board of Directors has standing Audit and Executive Committees.

       The Board of Directors' Audit Committee consists of Directors Keziah,
  Quakenbush and Stadler, who serves as Chairperson.  The Audit Committee met
  one time during the year ended September 30, 1998.  The function of the Audit
  Committee is to examine and approve the audit report prepared by the
  independent auditors of the Bank, to review and recommend the independent
  auditors to be engaged by the Bank, to review the internal audit function and
  internal accounting controls, and to review and approve audit policies.

       The Board of Directors' Executive Committee consists of Directors McGill,
  Barnwell, Shirley and Keziah and one additional director who serves on a
  rotating basis for a three-month period.  The Executive Committee, among other
  things, evaluates the compensation and benefits of the directors, officers and
  employees, recommends changes, and monitors and evaluates employee
  performance.  The Executive Committee reports its evaluations and findings to
  the full Board of Directors and all compensation decisions are ratified by the
  full Board of Directors.  Directors of the Bank who also are officers of the
  Bank abstain from discussion and voting on matters affecting their
  compensation. The Executive Committee also monitors the performance of the
  Bank's investment portfolio and reviews loans. The Executive Committee is
  empowered to exercise all of the authority of the Board when the Board is not
  in session. The Executive Committee met 12 times during the fiscal year ended
  September 30, 1998.

                                       86
<PAGE>
 
  EXECUTIVE COMPENSATION

       The following table sets forth the cash and noncash compensation for the
  last fiscal year awarded to or earned by the President and the four other
  executive officers of the Bank who earned salary and bonus in fiscal 1998
  exceeding $100,000 for services rendered in all capacities to the Bank.

  <TABLE>
  <CAPTION>
 
                                        Annual Compensation
                                   --------------------------------------------------
  Name and                         Fiscal                            Other Annual       All Other
  Principal Position               Year      Salary    Bonus         Compensation (1)  Compensation (2)
  ------------------               ----      ------    -----         ----------------  ----------------
  <S>                             <C>       <C>       <C>            <C>               <C>               
   James C. McGill                 1998      $175,000  $ 257,000          --              107,352
     President and Chief
     Executive Officer
 
  A. Christine Baker               1998        95,000    128,500          --               44,469
     Executive Vice President,
     Treasurer and Secretary
 
  Fairfax C. Reynolds              1998        95,000    128,500          --               44,476
     Executive Vice President
 
  Frank Gavigan                    1998        76,000     30,000          --               10,260
     Senior Vice President
 
  John D. Hansell                  1998        42,000     68,220  (3)     --                5,460
     Manager
  </TABLE>

  ---------------------
  (1)     Executive officers of the Bank receive indirect compensation in the
          form of certain perquisites and other personal benefits. The amount of
          such benefits received by the named executive officer in fiscal 1998
          did not exceed 10% of the executive officer's salary and bonus.

  (2)     Includes $4,800, $2,850, $2,850, $2,280 and $1,260 in matching
          contributions under the Bank's 401(k) Plan and $20,580, $10,830,
          $10,830, $7,980 and $4,200 in accruals made pursuant to the Bank's
          Money Purchase Pension Plan for executive officers McGill, Baker,
          Reynolds, Gavigan and Hansell, respectively. The Money Purchase
          Pension Plan was terminated effective September 30, 1998. Also
          includes $81,972, $30,789 and $33,766 accrued under our Deferred
          Compensation Plan for the benefit of executive officers McGill, Baker
          and Reynolds, respectively, for service as an employee during the year
          ended September 30, 1998. Does not include amounts accrued pursuant to
          such plan during the year ended September 30, 1998 for service in
          prior years.

  (3)     Consists of commissions.

          Employee Stock Ownership Plan.  We have established the ESOP for the
  exclusive benefit of our participating employees, to be implemented upon the
  completion of the Stock Conversion.  Participating employees are employees who
  have completed one year of service with us (including at least 1,000 hours of
  service) and have attained the age of 21.  An application for a letter of
  determination as to the tax-qualified status of the ESOP will be submitted to
  the IRS.  Although no assurances can be given, we expect that the ESOP will
  receive a favorable letter of determination from the IRS.

          The ESOP is to be funded by contributions made by us in cash or common
  stock.  Benefits may be paid either in shares of the common stock or in cash.
  In accordance with the Plan, the ESOP may borrow funds with which to acquire
  up to 8% of the common stock to be issued in the Stock Conversion.  The ESOP
  intends to borrow funds from the Company.  The loan is expected to be for a
  term of 10 years at an annual interest rate equal to the prime rate, adjusted
  annually on each October 1st.   Presently it is anticipated that the ESOP will
  purchase up to 8% of the common stock to be issued in the offering, including
  shares contributed to the Foundation (132,000 shares based on the midpoint of
  the Estimated Valuation Range and the contribution of 150,000 shares of common
  stock to the Foundation).  The loan will be secured by the shares purchased.
  Shares purchased with such loan proceeds will be held in a suspense account
 

                                       87
<PAGE>
 
for allocation among participant accounts as the loan is repaid. We anticipate
contributing approximately $264,000 annually (based on a 132,000 share purchase)
to the ESOP to meet principal obligations under the ESOP loan, as proposed. It
is anticipated that all such contributions will be tax-deductible. This loan is
expected to be fully repaid in approximately 10 years.

     Contributions to the ESOP and shares released from the suspense account
will be allocated among participant accounts on the basis of each participant's
annual wages subject to federal income tax withholding, plus any amounts
withheld under a plan qualified under Section 125 or 401(k) of the Code and
sponsored by us. All participants must be employed at least 500 hours in a plan
year in order to receive an allocation. Participants will become 20% vested in
their ESOP account balances beginning in their third year for each year of
service, up to a maximum of 100% for seven years of service, with no more than
five years of service credited for employment before October 1, 1998. Vesting
will be accelerated upon retirement, death, disability, change in control of the
Company, or termination of the ESOP. Forfeitures will be reallocated to
participants on the same basis as other contributions in the plan year. Benefits
will be payable in the form of a lump sum upon retirement, death, disability or
separation from service. Our contributions to the ESOP are discretionary and may
cause a reduction in other forms of compensation. Therefore, benefits payable
under the ESOP cannot be estimated.

     In the event of a change in control of the Company, the outstanding balance
of any loans used to finance the purchase of shares by the ESOP will be paid off
through a transfer or sale of shares held as collateral under such loan, with
any remaining shares allocated to participant accounts pro rata based on their
account balances. Participants terminating employment on or after the change in
control will be entitled to receive a cash payment from the Company or its
successor equal to the amount, if any, which would have been allocated to the
participant's account immediately following the change in control but was
precluded from allocation based on allocation limits applicable under federal
tax laws.

     The board of directors has appointed non-employee directors to the ESOP
Committee to administer the ESOP and to serve as the initial ESOP Trustees. The
board of directors or the ESOP Committee may instruct the ESOP Trustees
regarding investments of funds contributed to the ESOP. The ESOP Trustees must
vote all allocated shares held in the ESOP in accordance with the instructions
of the participating employees. Unallocated shares and allocated shares for
which no timely direction is received will be voted by the ESOP Trustees as
directed by the Board of Directors or the ESOP Committee, subject to the
Trustees' fiduciary duties.

     401(k) Plan. Our 401(k) Plan is being amended in connection with the
Conversion to allow participants initially and on an ongoing basis to direct
that all or part of their account balances be invested in Company common stock.
Participants will retain the right to vote those shares held in trust for them
under the 401(k) Plan.

     Employment Agreements and Guaranty Agreements. The Bank has entered into
employment agreements (the "Employment Agreements") with James C. McGill, A.
Christine Baker and Fairfax C. Reynolds (each an "Employee, and, collectively,
the "Employees"). The Board believes that the Employment Agreements assure fair
treatment of the Employees in their careers with the Bank by assuring them of
some financial security. The proposed Employment Agreements will require FDIC
approval prior to becoming effective.

     The Employment Agreements will become effective on the date of completion
of the Stock Conversion and will provide for a term of three years, with an
annual base salary equal to the Employee's existing base salary rate in effect
on the date of Stock Conversion. On each anniversary date of the commencement of
the Employment Agreements, the term of the Employee's employment will be
extended for an additional one-year period beyond the then effective expiration
date upon a determination by the Bank's Board of Directors that the performance
of the Employee has met the required performance standards and that such
Employment Agreements should be extended. The Employment Agreements provide the
Employee with a salary review by the Board of Directors not less often than
annually, as well as with inclusion in any discretionary bonus plans, retirement
and medical plans, customary fringe benefits, vacation and sick leave. If the
Board decides not to renew an Employment Agreement for any reason, and if

                                       88
<PAGE>
 
the Employee remains an employee of the Bank until the Agreement expires, the
Bank shall thereupon pay the Employee an amount equal to two times total
compensation.

     The Employment Agreements terminate upon the Employee's death, may
terminate upon the Employee's disability and is terminable by the Bank for "just
cause" (as defined in the Employment Agreements). In the event of termination
for just cause, no severance benefits are available. If the Bank terminates the
Employee without just cause, the Employee shall be entitled to receive three
times his total compensation as well as continued medical and dental insurance
under any group plan chosen by the Employee from the plans the Bank maintains,
unless that coverage is not permitted by the terms of such plan, whereby the
Bank shall remit to the Employee, not less frequently than monthly, the actual
cost to the Employee of equivalent insurance. These provisions shall be in
addition to, and not in lieu of, any other rights that the Employee has under
the Employment Agreement, and shall continue until the Employee first becomes
eligible for participation in Medicare. If the Employment Agreements are
terminated due to the Employee's "disability" (as defined in the Employment
Agreements), the Employee will be entitled to a continuation of his salary and
benefits through the date of such termination, including any period prior to the
establishment of the Employee's disability. In the event of the Employee's death
during the term of the Employment Agreements, his estate shall be entitled to
receive three times his total compensation determined as of the date of his
death. Each Employee is able to voluntarily terminate his or her Employment
Agreement by providing 90 days' written notice to the Board of Directors of the
Bank, in which case the Employee is entitled to receive only his or her
compensation, vested rights, and benefits up to the date of termination.

     In the event of (i) the Employee's involuntary termination of employment
other than for "just cause" during the period beginning six months before a
change in control and ending on the later of the first anniversary of the change
in control or the expiration date of the Employment Agreements (the "Protected
Period"), (ii) the Employee's voluntary termination within 90 days of the
occurrence of certain specified events occurring during the Protected Period
which have not been consented to by the Employee, or (iii) the Employee's
voluntary termination of employment for any reason within the 30-day period
beginning on the date of the change in control, the Bank shall (i) pay a
severance benefit equal to the difference between the product of 2.99 and the
Employee's "base amount" as defined in the Internal Revenue Code Section
280G(b)(3) and the sum of any other "parachute payments" as defined under Code
Section 280G(b)(2) that the Employee receives on account of the change in
control, and (ii) provide long-term disability and medical insurance for 18
months. The Employee shall be paid either (i) in one lump sum within ten days of
the later of the date of the change in control and the Employee's last day of
employment with the Bank or the Company, or (ii) if prior to the date which is
90 days before the date on which a change in control occurs, the Employee filed
a duly executed irrevocable written election, payment of such amount shall be
made according to the elected schedule. "Change in control" generally refers to
the acquisition, by any person or entity, of the ownership or power to vote more
than 25% of the Bank's or Company's voting stock, the control of the election of
a majority of the Bank's or the Company's directors, or the exercise of a
controlling influence over the management or policies of the Bank or the
Company. In addition, under the Employment Agreements, a change in control
occurs when, during any consecutive two-year period, directors of the Company or
the Bank at the beginning of such period cease to constitute two-thirds of the
Board of Directors of the Company or the Bank, unless the election of
replacement directors was approved by a two-thirds vote of the initial directors
then in office. The Employment Agreements provide that within 10 business days
of a change in control, the Bank shall deposit in a Trust an amount equal to the
Internal Revenue Code Section 280G maximum. The payments that would be made to
Mr. McGill, Ms. Baker and Mr. Reynolds assuming termination of employment under
the foregoing circumstances at September 30, 1998 would have been approximately
$1.1 million, $539,000 and $539,000, respectively. These provisions may have an
anti-takeover effect by making it more expensive for a potential acquiror to
obtain control of the Company. For more information, see "Certain Anti-Takeover
Provisions in the Articles of Incorporation and Bylaws -- Benefit Plans." In the
event that the Employee prevails over the Company and the Bank, or obtains a
written settlement, in a legal dispute as to the Employment Agreement, he or she
will be reimbursed for his legal and other expenses.

     In addition to the Employment Agreements, the Company has entered into
Guaranty Agreements with each of the Employees. The Guaranty Agreements provide
that the Company will perform all covenants and honor all

                                       89
<PAGE>
 
obligations required to be performed or to which the Bank is subject pursuant to
the Employment Agreements in the event that such covenants are not performed or
obligations are not honored by the Bank, and that to the extent permitted by
law, the Company will be jointly and severally liable with the Bank for the
payment of all amounts due under the Employment Agreements. The Guarantee
Agreements provide the Employee with a salary review by the Board of Directors
not less often than annually, as well as with inclusion in any discretionary
bonus plans, retirement and medical plans, customary fringe benefits, vacation
and sick leave.

DIRECTOR COMPENSATION

     Fees. Each non-employee member of the Bank's Board of Directors receives a
monthly retainer fee based on the following schedule: the Chairman of the Board
 - $2,000; members of the Executive Committee - $1,750; and other directors -
$1,500. Officers who are directors are not compensated for their service as
directors. Directors also will participate in certain of our benefit plans. See
" -- Proposed Future Stock Benefit Plans."

     Deferred Compensation Plan. We adopted the 1st State Bank Deferred
Compensation Plan, effective September 24, 1997 for our directors and select
executive officers. Under the plan, before each fiscal year begins, each non-
employee director may elect to defer receipt of all or part of his future fees
and any other participant may elect to defer receipt of up to 25% of his or her
salary or 100% of his or her bonus compensation for the year. Deferred amounts
are credited at the end of the calendar year to bookkeeping accounts in the name
of each participant.

     Pursuant to the terms of the plan, the accounts of directors Barnwell,
Bean, Keziah, McClure, Quakenbush, Shirley and Stadler were credited, on the
plan's effective date, with $79,152, $70,672, $90,460, $62,819, $70,672, $79,152
and $70,672, respectively, with respect to prior years of service up to nine
years. On each September 30 after 1997, the Bank will credit the accounts of
directors Barnwell, Bean, Keziah, McClure, Quakenbush, Shirley, and Stadler with
$8,795, $7,852, $10,051, $7,852, $7,852, $8,795 and $7,852, respectively,
provided that such annual credits shall not be made for the benefit of non-
employee directors after 12 years of service credits. Similarly, the plan
provides supplemental executive retirement benefits for executive officers
McGill, Baker and Reynolds through initial credits of $737,729, $277,098 and
$270,126, respectively, on September 24, 1997 and, through annual credits, on
each September 30th after 1997, of $81,972, $30,789 and $33,766, respectively.
Each participant is fully vested in his account balance under the Plan.

     Until distributed in accordance with the terms of the plan, each
participant's account will be credited with a rate of return equal to our
highest rate of interest paid on our one-year certificates of deposit. On and
after the Conversion, each participant may prospectively elect to instead have
all or part of his account credited with the total return on the common stock.
Account balances will normally be distributed in five substantially equal annual
installments beginning during the first quarter of the calendar year following
the calendar year in which the participant ceases to be a director or employee,
with any subsequent payments being made by the last day of the first quarter of
each subsequent calendar year until the participant has received the entire
amount of his or her account. Participants may, however, elect to receive their
distributions in a lump sum or in installments paid over a period of up to 10
years. In the event of a participant's death, the balance of his plan account
will be paid in a lump sum (unless the participant elects to continue the
previously designated distribution method) to his designated beneficiary, or if
none, his estate.

     We have established a trust in order to hold assets with which to pay plan
benefits to participants. Trust assets are subject to claims of general
creditors. In the event a participant prevails over us in a legal dispute as to
the terms or interpretation of the plan, he or she would be reimbursed for his
legal and other expenses.

PROPOSED FUTURE STOCK BENEFIT PLANS

     Stock Option Plan. We intend to adopt a stock option plan (the "Option
Plan") following the Stock Conversion, subject to approval by the Company's
stockholders if required by applicable law. We currently expect to implement
this plan no sooner than one year after the Stock Conversion. However, the
Company may hold a stockholders' meeting

                                       90
<PAGE>
 
as soon as six months after the Stock Conversion to adopt the Option Plan. If
the Option Plan is adopted during the first year following the Stock Conversion,
the Option Plan would be in compliance with the FDIC conversion regulations in
effect. See "--Restrictions on Stock Benefit Plans." If the Option Plan is
implemented more than one year after the Stock Conversion, which we expect, the
Option Plan will comply with FDIC regulations and policies that are applicable
at such time. If the Option Plan is implemented within one year after the Stock
Conversion, in accordance with FDIC regulations, a number of shares equal to 10%
of the aggregate shares of common stock to be issued in the Offering, including
shares contributed to the Foundation (i.e., 165,000 shares based upon the
issuance of 1,500,000 shares at the midpoint of the Estimated Valuation Range
and the contribution of 150,000 shares of common stock to the Foundation) would
be reserved for issuance by the Company upon exercise of stock options to be
granted to our officers, directors and employees from time to time under the
Option Plan. The purpose of the Option Plan would be to provide additional
performance and retention incentives to certain officers, directors and
employees by facilitating their purchase of a stock interest in the Company.
Under the FDIC regulations, the Option Plan would provide for a term of 10 years
after which no awards could be made, unless earlier terminated by the Board of
Directors pursuant to the Option Plan. The options would vest over a five year
period (i.e., 20% per year), beginning on the date of grant of the option, if
the Option Plan is implemented within one year of the Stock Conversion. Options
would expire no later than 10 years from the date granted and would expire
earlier if the Option Committee so determines or in the event of termination of
employment. Options would be granted based upon several factors, including
seniority, job duties and responsibilities, job performance, our financial
performance and a comparison of awards given by other savings institutions
converting from mutual to stock form.

       The Company would receive no monetary consideration for the granting of
stock options under the Option Plan. It would receive the option exercise price
for each share issued to optionees upon the exercise of such options. Shares
issued as a result of the exercise of options will be either authorized but
unissued shares or shares purchased in the open market by the Company. The
exercise of options and payment for the shares received would contribute to the
equity of the Company.

       Management Recognition Plan.  We intend to adopt the MRP following the
Stock Conversion, the objective of which is to enable us to retain personnel and
directors of experience and ability in key positions of responsibility. We
expect to implement the MRP no sooner than one year after the Stock Conversion
(subject to any stockholder approval required by law), but may elect instead to
hold a stockholders' meeting as early as six months after the Stock Conversion.
If the MRP is implemented within one year or more after the Stock Conversion, in
accordance with applicable FDIC regulations, the shares granted under the MRP
will be in the form of restricted stock vesting over a five- year period (i.e.,
20% per year) beginning one year after the date of grant of the award.
Additionally, the number of shares to be granted could not exceed 4% of the
shares sold in the Stock Conversion, including shares contributed to the
Foundation, if the MRP is adopted during the first year following Stock
Conversion. If the MRP is implemented more than one year after the Stock
Conversion, the MRP will comply with such FDIC regulations and policies that are
applicable at such time. Compensation expense in the amount of the fair market
value of the common stock granted will be recognized pro rata over the years
during which the shares are payable. Until they have vested, such shares may not
be sold, pledged or otherwise disposed of and are required to be held in escrow.
Any shares not so allocated would be voted by the MRP Trustees. Awards would be
granted based upon a number of factors, including seniority, job duties and
responsibilities, job performance, our performance and a comparison of awards
given by other institutions converting from mutual to stock form. The MRP would
be managed by a committee of non-employee directors (the "MRP Trustees"). The
MRP Trustees would have the responsibility to invest all funds contributed by us
to the trust created for the MRP (the "MRP Trust").

       We expect to contribute sufficient funds to the MRP so that the MRP Trust
can purchase, in the aggregate, up to 4% of the amount of common stock that is
sold in the Stock Conversion, including shares contributed to the Foundation.
The shares purchased by the MRP would be authorized but unissued shares or would
be purchased in the open market. Whether such shares will be purchased in the
open market or newly issued of the Company, and the timing of such purchases,
will depend on market and other conditions and the alternative uses of capital
available to the Company. In the event the market price of the common stock is
greater than $20.00 per share when awards are made,

                                       91
<PAGE>
 
our contribution of funds will be increased. Likewise, in the event the market
price is lower than $20.00 per share, our contribution will be decreased. In
recognition of their prior and expected services to us and the Company, as the
case may be, the officers, other employees and directors responsible for
implementation of the policies adopted by the Board of Directors and our
profitable operation will, without cost to them, be awarded stock under the MRP.
Based upon the issuance of 1,500,000 shares of common stock in the Offering at
the midpoint of the Estimated Valuation Range and the contribution of 150,000
shares of common stock to the Foundation, the MRP Trust is expected to purchase
up to 66,000 shares of common stock.

       Restrictions on Stock Benefit Plans.  FDIC regulations provide that in
the event we implement stock option or management and/or employee stock benefit
plans within one year from the date of conversion, such plans must comply with
the following restrictions: (i) the plans must be fully disclosed in the
prospectus; (ii) all plans must be approved by a majority of the total votes
eligible to be cast at any duly called meeting of the Company's stockholders
held no earlier than six months following the Stock Conversion; (iii) for stock
option plans, the exercise price must be at least equal to the market price of
the stock at the time of grant; and (iv) for restricted stock plans such as the
MRP, no stock issued in a conversion may be used to fund the plan. In addition,
the FDIC presumes that a stock option plan or management recognition plan that
does not conform to applicable Office of Thrift Supervision ("OTS") percentage
limitations constitutes excessive insider benefits. Such percentage limitations
are: (i) for stock option plans, the total number of shares for which options
may be granted may not exceed 10% of the shares issued in the conversion,
including shares issued to a charitable foundation; (ii) for restricted stock
plans such as the MRP, the shares may not exceed 3% of the shares issued in the
conversion, including shares issued to a charitable foundation (4% for
institutions with 10% or greater tangible capital); (iii) the aggregate amount
of stock purchased by the ESOP in the conversion may not exceed 10% (12% for
well-capitalized institutions utilizing a 4% management recognition plan) of the
shares issued in the conversion, including shares issued to a charitable
foundation; (iv) no individual employee may receive more than 25% of the
available awards under the option plan or the MRP; (v) directors who are not
employees may not receive more than 5% individually or 30% in the aggregate of
the awards under any plan; and (vi) neither stock option awards nor restricted
stock awards may vest earlier than 20% as of one year after the date of
stockholder approval and 20% per year thereafter, and vesting may be accelerated
only in the case of disability or death (or if not inconsistent with applicable
FDIC regulations in effect at such time, in the event of a change in control).

TRANSACTIONS WITH MANAGEMENT

       We offer loans to our directors and officers.  These loans were made in
the ordinary course of business on substantially the same terms, including
interest rates and collateral, as those prevailing at the time for comparable
transactions with other persons and did not involve more than the normal risk of
collectibility or present other unfavorable features. Under current law, our
loans to directors and executive officers are required to be made on
substantially the same terms, including interest rates, as those prevailing for
comparable transactions with other persons and must not involve more than the
normal risk of repayment or present other unfavorable features. Furthermore, all
loans to such persons must be approved in advance by a disinterested majority of
our Board of Directors. At September 30, 1998, our loans to our directors and
executive officers and their affiliates totaled $7.5 million, or 29.0% of our
net worth, at that date. See Note 3 of Notes to Consolidated Financial
Statements.


                    CERTAIN RESTRICTIONS ON ACQUISITION OF
                      THE COMPANY AND THE CONVERTED BANK

CONVERSION REGULATIONS

       Applicable North Carolina regulations provide that for a period of three
years following the Stock Conversion, the prior written approval of the
Administrator will be required before any person may, directly or indirectly,
acquire beneficial ownership of or make any offer to acquire any stock or other
equity security of the Company if, after the acquisition or consummation of such
offer, such person would be the beneficial owner of more than 10% of such class

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of stock or other class of equity security of the Company. If any person were to
so acquire the beneficial ownership of more than 10% of any class of any equity
security without prior written approval, the securities beneficially owned in
excess of 10% would not be counted as shares entitled to vote and would not be
voted or counted as voting shares in connection with any matter submitted to
stockholders for a vote. Approval is not required for (i) any offer with a view
toward public resale made exclusively to the Company or its underwriters or the
selling group acting on its behalf or (ii) any offer to acquire or acquisition
of beneficial ownership of more than 10% of the common stock of the Company by a
corporation whose ownership is or will be substantially the same as the
ownership of the Company, provided that the offer or acquisition is made more
than one year following the consummation of the Stock Conversion. The regulation
provides that within one year following the Stock Conversion, the Administrator
would approve the acquisition of more than 10% of beneficial ownership only to
protect the safety and soundness of the institution. During the second and third
years after the Stock Conversion, the Administrator may approve such an
acquisition upon a finding that (i) the acquisition is necessary to protect the
safety and soundness of the Company and the Bank or the Board of Directors of
the Company and the Bank support the acquisition and (ii) the acquiror is of
good character and integrity and possesses satisfactory managerial skills, the
acquiror will be a source of financial strength to the Company and the Bank and
the public interests will not be adversely affected.

CHANGE IN BANK CONTROL ACT AND BANK HOLDING COMPANY ACT

       The Change in Bank Control Act, together with North Carolina regulations,
require that the consent of the Administrator and Federal Reserve Board be
obtained prior to any person or company acquiring "control" of a North Carolina-
chartered savings bank or a North Carolina-chartered savings bank holding
company. The consent of the Commission and the Federal Reserve Board is required
to be obtained prior to any person or company acquiring "control" of a North
Carolina-chartered commercial bank. Upon acquiring control, such acquiror will
be deemed to be a bank holding company. Control is conclusively presumed to
exist if, among other things, an individual or company acquires the power,
directly or indirectly, to direct the management or policies of the Company or
the Bank or to vote 25% or more of any class of voting stock. Control is
rebuttably presumed to exist under the Change in Bank Control Act if, among
other things, a person acquires more than 10% of any class of voting stock, and
the issuer's securities are registered under Section 12 of the Exchange Act or
the person would be the single largest stockholder. Restrictions applicable to
the operations of bank holding companies and conditions imposed by the Federal
Reserve Board in connection with its approval of such acquisitions may deter
potential acquirors from seeking to obtain control of the Company. See
"Regulation -- Regulation of the Company Following the Bank Conversion."

VIRGINIA STOCK CORPORATION ACT

       The Virginia Stock Corporation Act ("VSCA") contains a statute designed
to provide Virginia corporations with additional protections against hostile
takeovers. The Virginia Affiliated Transactions Act restricts certain
transactions between a Virginia corporation and a holder of 10% or more of the
corporation's outstanding voting stock, together with affiliates or associates
thereof (an "Interested Shareholder"). For a period of three years following the
date that a stockholder becomes an Interested Shareholder, the Virginia
Affiliates Transactions Act generally prohibits the following types of
transactions between the corporation and the Interested Shareholder (unless
certain conditions, described below, are met): (i) mergers; (ii) sales, leases,
exchanges, mortgages, pledges, transfers or other dispositions (in one or a
series of transactions) having a total market value in excess of 5% of the
corporation's consolidated net worth; (iii) any guarantees of indebtedness of
any Interested Shareholder in an amount in excess of 5% of the corporation's
consolidated net worth; (iv) sales or other dispositions by the corporation or
any subsidiary thereof of any voting shares of the corporation or any subsidiary
thereof having a market value of 5% or more of the total market value of the
outstanding voting shares of the corporation to any Interested Stockholder or
affiliate of any Interested Stockholder other than pursuant to a stock dividend
or the exercise of rights or warrants; (v) the dissolution of the corporation if
proposed by or on behalf of an Interested Stockholder; (vi) any reclassification
of securities, including any reverse stock split, or recapitalization of the
corporation, or any merger of the corporation with any of its subsidiaries or
any distribution or other transaction which has the effect directly or
indirectly of increasing by more than 5% the percentage of the outstanding
voting shares of the corporation or any of its subsidiaries beneficially owned
by

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any Interested Shareholder; and (vii) any share exchange in which an Interested
Shareholder acquires a class or series of the corporation's voting stock, unless
the affiliated transaction is approved by (a) a majority of the disinterested
directors, and (b) two-thirds of the disinterested voting shares. Additionally,
after the three-year prohibition on affiliated transactions has expired, an
affiliated transaction must be approved by two-thirds of the votes cast by
disinterested stockholders.

       The foregoing voting requirements do not apply if the particular
affiliated transaction (i) has been approved by a majority of the disinterested
directors; (ii) meets the rigorous fair price requirements of the Virginia
Affiliated Transactions Act; or (iii) qualifies for one of the statutory
exemptions. A Virginia corporation may exempt itself from the requirements of
the statute in its articles of incorporation. In this regard, the Company has
not exempted itself from the provisions of the Virginia Affiliated Transactions
Act. Additionally, the Virginia Affiliated Transactions Act does not apply to
corporations with less than 300 shareholders of record.

       The Virginia Control Share Acquisitions Act prohibits voting rights of
common stock of any person who acquires either (i) one-fifth or more, but less
than one-third, of all voting power of the corporation; (ii) one-third or more,
but less than a majority, of the voting power of the corporation; or (iii) a
majority or more of the voting power of the corporation, unless such person has
delivered an acquiring person's statement to the corporation, and such voting
rights are approved by a majority of the disinterested shares of stock eligible
to vote on the election of directors. A Virginia corporation may include a
provision in its articles of incorporation or bylaws exempting the corporation
from Virginia's Control Share Acquisitions Statute. The Company, however, has
not exempted itself from the provisions of Virginia's Control Share Acquisitions
Statute. In addition, Virginia's Control Share Acquisitions Statute does not
apply to corporations with less than 300 shareholders.


                       CERTAIN ANTI-TAKEOVER PROVISIONS
                  IN THE ARTICLES OF INCORPORATION AND BYLAWS

       While the Boards of Directors of the Company and the Bank are not aware
of any effort that might be made to obtain control of the Company after the
Conversion, the Company's Board of Directors, as discussed below, believes that
it is appropriate to include certain provisions as part of the Company's
Articles of Incorporation to protect the interests of the Company and its
stockholders from hostile takeovers which the Board of Directors might conclude
are not in the best interests of the Converted Bank, the Company or the
Company's stockholders. These provisions may have the effect of discouraging a
future takeover attempt which is not approved by the Board of Directors but
which individual stockholders may deem to be in their best interests or in which
stockholders may receive a substantial premium for their shares over then
current market prices. As a result, stockholders who might desire to participate
in such a transaction may not have an opportunity to do so. Such provisions also
will render the removal of the current Board of Directors or management of the
Company more difficult.

       The following discussion is a general summary of certain provisions of
the Articles of Incorporation and Bylaws of the Company which may be deemed to
have such an "anti-takeover" effect. The description of these provisions is
necessarily general and reference should be made in each case to the Articles of
Incorporation and Bylaws of the Company. For information regarding how to obtain
a copy of these documents without charge, see "Additional Information."

CLASSIFIED BOARD OF DIRECTORS AND RELATED PROVISIONS

       The Company's Articles of Incorporation provide that the Board of
Directors is to be divided into three classes which shall be as nearly equal in
number as possible. The directors in each class will hold office following their
initial appointment to office for terms of one year, two years and three years,
respectively, and, upon reelection, will serve for terms of three years
thereafter. Each director will serve until his or her successor is elected and
qualified. The Articles

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<PAGE>
 
of Incorporation provide that a director may be removed only for cause and only
by the affirmative vote of the holders of at least 80% of the outstanding shares
entitled to vote.

       A classified Board of Directors could make it more difficult for
stockholders, including those holding a majority of the outstanding shares, to
force an immediate change in the composition of a majority of the Board of
Directors. Since the terms of only one-third of the incumbent directors expire
each year, it requires at least two annual elections for the shareholders to
change a majority, whereas a majority of a non-classified board may be changed
in one year. In the absence of the provisions of the Articles of Incorporation
classifying the Board, all of the directors would be elected each year.

       Management of the Company believes that the staggered election of
directors tends to promote continuity of management because only one-third of
the Board of Directors is subject to election each year. Staggered terms
guarantee that in the ordinary course approximately two-thirds of the Directors,
or more, at any one time have had at least one year's experience as Directors of
the Company, and moderate the pace of changes in the Board of Directors by
extending the minimum time required to elect a majority of Directors from one to
two years.

STOCKHOLDER VOTE REQUIRED TO APPROVE BUSINESS COMBINATIONS WITH PRINCIPAL
STOCKHOLDERS

       The Company's Articles of Incorporation require the approval of the
holders of (i) at least 80% of the Company's outstanding shares of voting stock,
and (ii) at least a majority of the Company's outstanding shares of voting
stock, not including shares deemed beneficially owned by a "Related Person," to
approve certain "Business Combinations" as defined in the Articles of
Incorporation, and related transactions. Under Virginia law, in addition to this
provision, Business Combinations would be subject to the Virginia Affiliated
Transactions Act and, subject to certain exceptions, must be approved by the
vote of the holders of at least a two-thirds of the outstanding disinterested
shares of common stock. For a discussion of the Virginia statutory voting and
other requirements, see "Certain Restrictions on Acquisition of the Company and
the Converted Bank -- Virginia Stock Corporation Act." The increased voting
requirements in the Company's Articles of Incorporation apply in connection with
business combinations involving a "Related Person," except in cases where the
proposed transaction has been approved in advance by two-thirds of those members
of the Company's Board of Directors who are unaffiliated with the Related Person
and who were directors prior to the time when the Related Person became a
Related Person (the "Continuing Directors"). The term "Related Person" is
defined to include any individual, corporation, partnership or other entity or
affiliate thereof which owns beneficially or controls, directly or indirectly,
10% or more of the outstanding shares of common stock of the Company. A
"Business Combination" is defined to include (i) any merger or consolidation of
the Company with or into a Related Person; (ii) any sale, lease exchange,
transfer, or other disposition of all or a substantial part of the assets of the
Company or of a subsidiary to a Related Person (the term "substantial part" is
defined to include more than 25% of the Company's total assets); (iii) any
merger or consolidation of a Related Person with or into the Company or a
subsidiary of the Company; (iv) any sale, lease, exchange, transfer or other
disposition of all or any substantial part of the assets of a Related Person to
the Company or a subsidiary of the Company; (v) the issuance of any securities
of the Company or a subsidiary of the Company to a Related Person; (vi) the
acquisition by the Company or a subsidiary of the Company of any securities of
the Related Person; (vii) any reclassification of the common stock, or any
recapitalization involving the common stock; and (viii) any agreement, contract
or other arrangement providing for any of the above transactions.

LIMITATIONS ON CALL OF MEETINGS OF STOCKHOLDERS

       The Company's Articles of Incorporation provide that special meetings of
stockholders may only be called by the Company's Board of Directors, President
or an appropriate committee appointed by the Board of Directors. Stockholders
are not authorized to call a special meeting, and stockholder action may be
taken only at a special or annual meeting of stockholders or if a consent in
writing setting forth the action taken is signed by all of the stockholders
entitled to vote on the matter.

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<PAGE>
 
ABSENCE OF CUMULATIVE VOTING

       The Company's Articles of Incorporation provide that there shall not be
cumulative voting by stockholders for the election of the Company's directors.
The absence of cumulative voting rights effectively means that the holders of a
majority of the shares voted at a meeting of stockholders may, if they so
choose, elect all directors of the Company to be elected at that meeting, thus
precluding minority stockholder representation on the Company's Board of
Directors.

RESTRICTIONS ON ACQUISITIONS OF SECURITIES

       The Articles of Incorporation provide that for a period of three years
from the effective date of the Stock Conversion, no person may directly or
indirectly offer to acquire or acquire the beneficial ownership of more than 10%
of any class of the equity security of the Company, unless such offer or
acquisition shall have been approved in advance by a two-thirds vote of the
Company's Continuing Directors. This provision does not apply to any employee
stock benefit plan of the Company or to an underwriter or member of an
underwriting or selling group involving the public sale or resale of securities
of the Company or a subsidiary thereof; provided, that upon completion of the
sale or resale, no such underwriter or member of the selling group is a
beneficial owner of more than 10% of any class of equity securities of the
Company. In addition, during such three-year period, no shares beneficially
owned in violation of the foregoing percentage limitation, as determined by the
Company's Board of Directors, shall be entitled to vote in connection with any
matter submitted to stockholders for a vote. Additionally, the Articles of
Incorporation provide for further restrictions on voting rights of shares owned
in excess of 10% of any class of equity security of the Company beyond three
years after the Stock Conversion. Specifically, the Articles of Incorporation
provide that if, at any time after three years from the Bank's conversion to
stock form, any person acquires the beneficial ownership of more than 10% of any
class of equity security of the Company, then, with respect to each vote in
excess of 10%, the record holders of voting stock of the Company beneficially
owned by such person shall be entitled to cast only one-hundredth of one vote
with respect to each vote in excess of 10% of the voting power of the
outstanding shares of voting stock of the Company which such record holders
would otherwise be entitled to cast without giving effect to the provision, and
the aggregate voting power of such record holders shall be allocated
proportionately among such record holders. An exception from the restriction is
provided if the acquisition of more than 10% of the securities received the
prior approval by a two-thirds vote of the Company's Continuing Directors. Under
the Company's Articles of Incorporation, the restriction on voting shares
beneficially owned in violation of the foregoing limitations is imposed
automatically. In order to prevent the imposition of such restrictions, the
Board of Directors must take affirmative action approving in advance a
particular offer to acquire or acquisition. Unless the Board took such
affirmative action, the provision would operate to restrict the voting by
beneficial owners of more than 10% of the Company's common stock in a proxy
contest.

BOARD CONSIDERATION OF CERTAIN NONMONETARY FACTORS IN THE EVENT OF AN OFFER BY
ANOTHER PARTY

       The Articles of Incorporation of the Company permit the Board of
Directors, in evaluating a Business Combination or a tender or exchange offer,
to consider, in addition to the adequacy of the amount to be paid in connection
with any such transaction, certain specified factors and any other factors the
Board deems relevant, including (i) the social and economic effects of the
transaction on the Company and its subsidiaries, employees, depositors, loan and
other customers, creditors and other elements of the communities in which the
Company and its subsidiaries operate or are located; (ii) the business and
financial condition and earnings prospects of the acquiring person or entity;
and (iii) the competence, experience and integrity of the acquiring person or
entity and its or their management. By having the standards in the Articles of
Incorporation of the Company, the Board of Directors may be in a stronger
position to oppose any proposed Business Combination or tender or exchange offer
if the Board concludes that the transaction would not be in the best interest of
the Company, even if the price offered is significantly greater than the then
market price of any equity security of the Company.

       The Board of Directors feels a responsibility for maintaining the
financial and business integrity of the Company. Savings institutions and banks
and their holding companies occupy positions of special trust in the

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<PAGE>
 
communities they serve. They also provide opportunities for abuse by those who
are not of sufficient experience or competence or financial means to act
professionally and responsibly with respect to management of a financial
institution. It is of concern to the Company that it be managed in the interest
of the communities that it serves and that it and its subsidiary bank maintain
their integrity as institutions.

       One effect of this provision might be to encourage consultation by an
offeror with the Board of Directors prior to or after commencing a tender offer
in an attempt to prevent a contest from developing. This provision thus may
strengthen the Board of Directors' position in dealing with any potential
offeror which might attempt to effect a takeover of the Company. The provision
will not make a Business Combination regarded by the Board of Directors as being
in the interests of the Company more difficult to accomplish, but it will permit
the Board of Directors to determine whether a Business Combination or tender or
exchange offer is not in the interests of the Company (and thus to oppose it) on
the basis of various factors deemed relevant.

AUTHORIZATION OF PREFERRED STOCK

       The Company's Articles of Incorporation authorize the issuance of up to
1,000,000 shares of preferred stock, which conceivably could represent an
additional class of stock required to approve any proposed acquisition. The
Company is authorized to issue preferred stock from time to time in one or more
series subject to applicable provisions of law, and the Board of Directors is
authorized to fix the powers, designations, preferences and relative,
participating, optional and other special rights of such shares, including
voting rights and conversion rights. Issuance of the preferred stock could
adversely affect the relative voting rights of holders of the common stock. In
the event of a proposed merger, tender offer or other attempt to gain control of
the Company that the Board of Directors did not approve, it might be possible
for the Board of Directors to authorized the issuance of a series of preferred
stock with rights and preferences that would impede the completion of such a
transaction. An effect of the possible issuance of preferred stock, therefore,
may be to deter a future takeover attempt. The Board of Directors has no present
plans or understandings for the issuance of any preferred stock and does not
intend to issue any preferred stock except on terms which the Board of Directors
deems to be in the best interests of the Company and its stockholders. This
preferred stock, none of which has been issued by the Company, together with
authorized but unissued shares of common stock (the Articles of Incorporation
authorizes the issuance of up to 7,000,000 shares of common stock), also could
represent additional capital required to be purchased by the acquiror.

PROCEDURES FOR STOCKHOLDER NOMINATIONS

       The Company's Articles of Incorporation provide that any stockholder
desiring to make a nomination for the election of directors or a proposal for
new business at a meeting of stockholders must submit written notice to the
Secretary of the Company not less than 30 or more than 60 days in advance of the
meeting. The Articles of Incorporation further provides that if a stockholder
seeking to make a nomination or a proposal for new business fails to follow the
prescribed procedures, the chairman of the meeting may disregard the defective
nomination or proposal. Management believes that it is in the best interests of
the Company and its stockholders to provide sufficient time to enable management
to disclose to stockholders information about a dissident slate of nominations
for directors. This advance notice requirement may also give management time to
solicit its own proxies in an attempt to defeat any dissident slate of
nominations should management determine that doing so is in the best interest of
stockholders generally. Similarly, adequate advance notice of stockholder
proposals will give management time to study such proposals and to determine
whether to recommend to the stockholders that such proposals be adopted.

AMENDMENT OF BYLAWS

       The Company's Articles of Incorporation provides that the Company's
Bylaws may be amended either by a two-thirds vote of the Company's Board of
Directors or by the affirmative vote of the holders of not less than 80% of the
outstanding shares of the Company's stock entitled to vote generally in the
election of directors. The Company's Bylaws contain numerous provisions
concerning the Company's governance, such as fixing the number of directors. By

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reducing the ability of a potential corporate raider to make changes in the
Company's Bylaws and to reduce the authority of the Board of Directors or impede
its ability to manage the Company, this provision could have the effect of
discouraging a tender offer or other takeover attempt where the ability to make
fundamental changes through bylaw amendments is an important element of the
takeover strategy of the acquiror.

AMENDMENT OF ARTICLES OF INCORPORATION

       The Company's Articles of Incorporation provide that specified provisions
contained in the Articles of Incorporation may not be repealed or amended except
upon the affirmative vote of not less than 80% of the outstanding shares of the
Company's stock entitled to vote generally in the election of directors, after
giving effect to any limits on voting rights. This requirement exceeds the two-
thirds vote of the outstanding stock that would otherwise be required by
Virginia law for the repeal or amendment of a provision of the Articles of
Incorporation. The specific provisions are those (i) governing the calling of
special meetings, the absence of cumulative voting rights and the requirement
that stockholder action be taken only at annual or special meetings or by
unanimous written consent, (ii) requiring written notice to the Company of
nominations for the election of directors and new business proposals, (iii)
governing the number of the Company's Directors, the filling of vacancies on the
Board of Directors and classification of the Board of Directors, (iv) providing
the mechanism for removing directors, (v) limiting the acquisition of 10% or
more of the capital stock of the Company (except, with the prior approval of the
Continuing Directors of the Company), (vi) governing the requirement for the
approval of certain Business Combinations involving a "Related Person," (vii)
regarding the consideration of certain nonmonetary factors in the event of an
offer by another party, (viii) providing for the indemnification of directors,
officers, employees and agents of the Company, (ix) pertaining to the
elimination of the liability of the directors to the Company and its
stockholders for monetary damages, with certain exceptions, and (x) governing
the required stockholder vote for amending the Articles of Incorporation or
Bylaws of the Company. This provision is intended to prevent the holders of less
than 80% of the outstanding stock of the Company from circumventing any of the
foregoing provisions by amending the Articles of Incorporation to delete or
modify one of such provisions. This provision would enable the holders of more
than 20% of the Company's voting stock to prevent amendments to the Company's
Articles of Incorporation or Bylaws, even if such amendments were favored by the
holders of a majority of the voting stock.

BENEFIT PLANS

       In addition to the provisions of the Company's Articles of Incorporation
and Bylaws described above, certain benefit plans of the Company and the
Converted Bank adopted in connection with the Conversion contain provisions
which also may discourage hostile takeover attempts which the Boards of
Directors of the Converted Bank might conclude are not in the best interests of
the Company, the Converted Bank or the Company's stockholders. For a description
of the benefit plans and the provisions of such plans relating to changes in
control of the Company or the Converted Bank, see "Management of the Bank --
Proposed Future Stock Benefit Plans."

THE PURPOSE OF AND ANTI-TAKEOVER EFFECT OF THE COMPANY'S ARTICLES OF
INCORPORATION AND BYLAWS

       We believe that the provisions described above reduce the Company's
vulnerability to takeover attempts and certain other transactions which have not
been negotiated with and approved by our Board of Directors. These provisions
will also assist the Company and the Converted Bank in the orderly deployment of
the net proceeds of the Stock Conversion into productive assets during the
initial period after the Stock Conversion. We believe these provisions are in
the best interests of the Converted Bank and of the Company and its
stockholders. In our judgment, the Company's Board of Directors is in the best
position to consider all relevant factors and to negotiate for what is in the
best interests of the stockholders and the Company's other constituents.
Accordingly, we believe that it is in the best interests of the Company and its
stockholders to encourage potential acquirors to negotiate directly with the
Company's Board of Directors, and that these provisions will encourage such
negotiations and discourage nonnegotiated takeover attempts. It is also our view
that these provisions should not discourage persons from proposing a merger or
other transaction at prices reflective of the true value of the Company and
which are in the best interests of all stockholders.

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<PAGE>
 
       Attempts to acquire control of financial institutions and their holding
companies have become increasingly common. Takeover attempts which have not been
negotiated with and approved by the Board of Directors present to stockholders
the risk of a takeover on terms which may be less favorable than might otherwise
be available. A transaction which is negotiated and approved by the Board of
Directors, on the other hand, can be carefully planned and undertaken at an
opportune time in order to obtain maximum value for the Company and
stockholders, with due consideration given to matters such as the management and
business of the acquiring corporation and maximum strategic development of the
Company's assets.

       An unsolicited takeover proposal can seriously disrupt the business and
management of a corporation and cause great expense. Although a tender offer or
other takeover attempt may be made at a price substantially above then current
market prices, such offers are sometimes made for less than all the outstanding
shares of a target company. As a result, stockholders may be presented with the
alternative of partially liquidating their investment at a time that may be
disadvantageous, or retaining their investment in an enterprise which is under
different management and whose objectives may not be similar to those of the
remaining stockholders. The concentration of control that could result from a
tender offer or other takeover attempt could also deprive the Company's
remaining stockholders of certain protective provisions of the Exchange Act.

       Despite our belief as to the benefits to stockholders of these provisions
of the Company's Articles of Incorporation and Bylaws, these provisions may also
have the effect of discouraging a future takeover attempt which would not be
approved by the Company's Board of Directors but pursuant to which the
stockholders may receive a substantial premium for their shares over then
current market prices. As a result, stockholders who might desire to participate
in such a transaction may not have any opportunity to do so. Such provisions
will also render the removal of the Company's Board of Directors and management
more difficult and may tend to stabilize the Company's stock price, thus
limiting gains which might otherwise be reflected in price increases due to a
potential merger or acquisition. The Board of Directors, however, has concluded
that the potential benefits of these provisions outweigh the possible
disadvantages. Pursuant to applicable regulations, at any annual or special
meeting of its stockholders after the Stock Conversion, the Company may adopt
additional Articles of Incorporation provisions regarding the acquisition of its
equity securities that would be permitted to a Virginia corporation. We do not
presently intend to propose the adoption of further restrictions on the
acquisition of the Company's equity securities.

                         DESCRIPTION OF CAPITAL STOCK

GENERAL

       The Company is authorized to issue 7,000,000 shares of common stock, par
value $.01 per share, and 1,000,000 shares of serial preferred stock, $.01 par
value per share. The Company currently expects to sell between 1,275,000 and
1,725,000 shares, subject to adjustment, of the common stock, and issue 150,000
shares of common stock to the Foundation, in the Stock Conversion. The Company
will not issue any shares of serial preferred stock in the Stock Conversion. If
the Option Plan is adopted and implemented, the Company will reserve for future
issuance under the Option Plan an amount of authorized but unissued shares of
common stock equal to 10% of the shares to be issued in the Stock Conversion,
including shares to be contributed to the Foundation. THE CAPITAL STOCK OF THE
COMPANY WILL REPRESENT NONWITHDRAWABLE CAPITAL, WILL NOT BE AN ACCOUNT OF AN
INSURABLE TYPE, AND WILL NOT BE INSURED BY THE FDIC OR ANY OTHER FEDERAL OR
STATE GOVERNMENTAL AGENCY.

COMMON STOCK

       Voting Rights.  Each share of the common stock will have the same
relative rights and will be identical in all respects with every other share of
the common stock. The holders of the common stock will possess exclusive voting

                                       99
<PAGE>
 
rights in the Company, except to the extent that shares of serial preferred
stock issued in the future may have voting rights, if any. Each holder of shares
of the common stock will be entitled to one vote for each share held of record
on all matters submitted to a vote of holders of shares of the common stock.
Stockholders are not permitted to cumulate votes in the election of directors.
For information regarding a possible reduction in voting rights, see "Certain
Anti-Takeover Provisions in the Articles of Incorporation and Bylaws --
Restrictions on Acquisitions of Securities."

       Dividends.  The Company may, from time to time, declare dividends to the
holders of the common stock, who will be entitled to share equally in any such
dividends. For information as to cash dividends, see "Dividend Policy,"
"Regulation -- Depository Institution Regulation -- Dividend Restrictions" and
"Taxation."

       Liquidation.  In the event of any liquidation, dissolution or winding up
of the Converted Bank, the Company, as holder of all of the Converted Bank's
capital stock, would be entitled to receive all assets of the Converted Bank
after payment of all debts and liabilities of the Converted Bank and after
distribution of the balance in the liquidation account to Eligible Account
Holders and Supplemental Eligible Account Holders. In the event of a
liquidation, dissolution or winding up of the Company, each holder of shares of
the common stock would be entitled to receive, after payment of all debts and
liabilities of the Company, a pro rata portion of all assets of the Company
available for distribution to holders of the common stock. If any serial
preferred stock is issued, the holders thereof may have a priority in
liquidation or dissolution over the holders of the common stock. The Bank
Conversion shall not be considered a "liquidation" of the Converted Bank, and
after the Bank Conversion the Converted Bank will continue to maintain the
liquidation account established by the Converted Bank in the Stock Conversion
according to the same terms.

       Restrictions on Acquisition of the Common Stock.  For information
regarding limitations on acquisition of shares of the common stock, see "Certain
Restrictions on Acquisition of the Company and the Converted Bank," "Certain
Anti-Takeover Provisions in the Articles of Incorporation and Bylaws."

       Other Characteristics.  Holders of the common stock will not have
preemptive rights with respect to any additional shares of the common stock
which may be issued. Therefore, the Board of Directors may sell shares of
capital stock of the Company without first offering such shares to existing
shareholders of the Company. The common stock is not subject to call for
redemption, and the outstanding shares of the common stock, when issued and upon
receipt by the Company of the full purchase price therefor, will be fully paid
and nonassessable.

       Transfer Agent and Registrar.  The transfer agent and registrar for the
common stock will be____________,  _______, ____________.

SERIAL PREFERRED STOCK

       None of the 1,000,000 authorized shares of serial preferred stock of the
Company will be issued in the Stock Conversion. After the Stock Conversion is
completed, the Board of Directors of the Company will be authorized to issue
serial preferred stock and to fix and state voting powers, designations,
preferences or other special rights of such shares and the qualifications,
limitations and restrictions thereof. The serial preferred stock may rank prior
to the common stock as to dividend rights or liquidation preferences, or both,
and may have full or limited voting rights. The Board of Directors has no
present intention to issue any of the serial preferred stock. Should the Board
of Directors of the Company subsequently issue serial preferred stock, no holder
of any such stock shall have any preemptive right to subscribe for or purchase
any stock or any other securities of the Company other than such, if any, as the
Board of Directors, in its sole discretion, may determine and at such price or
prices and upon such other terms as the Board of Directors, in its sole
discretion, may fix.

                                      100
<PAGE>
 
                           REGISTRATION REQUIREMENTS

       The Company will register its common stock with the SEC pursuant to the
Exchange Act upon the completion of the Stock Conversion and will not deregister
said shares for a period of at least three years following the completion of the
Stock Conversion. Upon such registration, the proxy and tender offer rules,
insider trading reporting and restrictions, annual and periodic reporting and
other requirements of the Exchange Act will be applicable. The Company intends
to have a fiscal year end of September 30.


                                 LEGAL MATTERS

       The legality of the common stock will be passed upon for the Company by
Housley Kantarian & Bronstein, P.C., Washington, D.C. Housley Kantarian &
Bronstein, P.C. has consented to the references herein to its opinion. Certain
legal matters will be passed upon for Trident Securities by Patton Boggs LLP,
Washington, D.C.


                                 TAX OPINIONS

       The federal income tax consequences of the Stock Conversion will be
passed upon by Housley Kantarian & Bronstein, P.C., Washington, D.C. Housley
Kantarian & Bronstein, P.C. has consented to the references herein to its
opinion. The North Carolina income tax consequences of the Stock Conversion will
be passed upon by KPMG Peat Marwick LLP, which has consented to the references
herein to its opinion.


                                    EXPERTS

       The consolidated financial statements of 1st State Bank and subsidiary as
of September 30, 1998 and 1997, and for each of the years in the three-year
period ended September 30, 1998, have been included herein and in the
registration statement in reliance upon the report of KPMG Peat Marwick LLP,
independent certified public accountants, appearing elsewhere herein, and upon
the authority of said firm as experts in accounting and auditing.

       Ferguson has consented to the publication herein of the summary of its
letter to us setting forth its opinion as to the estimated pro forma aggregate
market value of the common stock to be issued in the Stock Conversion and the
value of subscription rights to purchase the common stock and to the use of its
name and statements with respect to it appearing in this document.


                            ADDITIONAL INFORMATION

       The Company has filed with the SEC a Registration Statement on Form S-1
under the Securities Act with respect to the common stock offered in this
document. As permitted by the rules and regulations of the SEC, this document
does not contain all the information set forth in the registration statement.
Such information can be examined without charge at the public reference
facilities of the SEC located at 450 Fifth Street, N.W., Washington, D.C. 20549,
and copies of such material can be obtained from the SEC at prescribed rates.
You may obtain information on the operation of the SEC's public reference room
by calling the SEC at 1-800-SEC-0330. The SEC also maintains an internet address
("web site") that contains reports, proxy and information statements and other
information regarding registrants, including the Company, that file
electronically with the SEC. The address for this web site is " http: //www.
sec. gov." The statements contained in this document as to the contents of any
contract or other document filed as an exhibit to the Form S-1 describe the
material features of such contract or document are, of necessity, brief
descriptions and are not necessarily complete; each such statement is qualified
by reference to such contract or document.

                                      101
<PAGE>
 
       We have filed an Application to Convert a Mutual Savings Bank to a Stock
Owned Savings Bank with the Administrator. Pursuant to the North Carolina
conversion regulations, this Prospectus omits certain information contained in
that Application. The Application, which contains a copy of Ferguson's
appraisal, may be inspected at the office of the Administrator, Savings
Institutions Division, North Carolina Department of Commerce, Tower Building,
Suite 301, 1110 Navaho Drive, Raleigh, North Carolina 27609. Copies of the Plan
of Conversion, which includes a copy of the Converted Bank's proposed Amended
and Restated Articles of Incorporation and Bylaws, are available for inspection
at each office of the Bank and may be obtained by writing to the Bank at 445 S.
Main Street, Burlington, North Carolina 27815; Attention James C. McGill,
President or by telephoning the Bank at (336) 227-8861. A copy of Ferguson's
independent appraisal is also available for inspection at the Stock Information
Center.

                                      102
<PAGE>
 
                  INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

<TABLE>
<CAPTION>
                                                                      Page
                                                                      ----
<S>                                                                   <C>
Independent Auditors' Report                                          F-1
                                                                        
Consolidated Balance Sheets as of  September 30, 1998 and 1997        F-2
                                                                        
Consolidated Statements of Income for the Years Ended                 F-3
  September 30, 1998, 1997 and 1996                                     
                                                                        
Consolidated Statements of Net Worth for the Years Ended              F-4
  September 30, 1998, 1997 and 1996                                     
                                                                        
Consolidated Statements of Cash Flows for the Years Ended             F-5
  September 30, 1998, 1997 and 1996                                     
                                                                        
Notes to Consolidated Financial Statements                            F-7
</TABLE> 

Schedules - All schedules are omitted because the required information is not
applicable or is presented in the financial statements or accompanying notes.

       All financial statements of 1st State Bancorp, Inc. have been omitted
because 1st State Bancorp, Inc. has not yet issued any stock, has no assets and
no liabilities and has not conducted any business other than of an
organizational nature.

                                      103
<PAGE>
 
                         INDEPENDENT AUDITORS' REPORT

The Board of Directors
1st State Bank
Burlington, North Carolina

We have audited the accompanying consolidated balance sheets of 1st State Bank
and subsidiary as of September 30, 1998 and 1997 and the related consolidated
statements of income, net worth and cash flows for each of the years in the
three-year period ended September 30, 1998. These consolidated financial
statements are the responsibility of the Bank's management. Our responsibility
is to express an opinion on these consolidated financial statements based on our
audits.

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

In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of 1st State Bank and
subsidiary at September 30, 1998 and 1997, and the results of their operations
and their cash flows for each of the years in the three-year period ended
September 30, 1998, in conformity with generally accepted accounting principles.
 

                                    /s/ KPMG Peat Marwick LLP 
                                    KPMG Peat Marwick LLP




Greensboro, North Carolina
October 30, 1998

                                      F-1
<PAGE>

                         1ST STATE BANK AND SUBSIDIARY

                          Consolidated Balance Sheets

                          September 30, 1998 and 1997


<TABLE>
<CAPTION>
                                  ASSETS                                            1998                1997
                                                                               ----------------   -----------------
<S>                                                                           <C>                 <C>
Cash and cash equivalents                                                     $     31,077,054          14,990,413
Investment securities (note 2):
    Held to maturity (fair value of $30,415,447 and $23,539,770
       at September 30, 1998 and 1997, respectively)                                30,195,094          23,481,510
    Available for sale (cost of $9,705,529 and $11,441,164 at
       September 30, 1998 and 1997, respectively)                                    9,857,780          11,319,777
Loans held for sale, at lower of cost or fair value                                  7,539,919             684,438
Loans receivable (net of allowance for loan losses of $3,227,775
    and $2,753,793 at September 30 1998 and 1997, respectively)
    (notes 3, 4 and 8)                                                             196,782,275         197,121,798
Federal Home Loan Bank stock, at cost (notes 5 and 8)                                1,346,500           1,281,200
Premises and equipment (note 6)                                                      7,513,347           6,771,800
Accrued interest receivable                                                          1,807,588           1,556,828
Other assets (note 10)                                                               2,103,659           1,301,640
                                                                               ----------------   -----------------
                  Total assets                                                $    288,223,216         258,509,404
                                                                               ================   =================

                         LIABILITIES AND NET WORTH

Liabilities:
    Deposit accounts (note 7)                                                 $    235,693,715         229,340,603
    Advances from Federal Home Loan Bank (note 8)                                   20,000,000           1,000,000
    Advance payments by borrowers for property taxes and
       insurance                                                                       299,939             387,799
    Other liabilities (notes 10 and 11)                                              6,263,957           4,503,659
                                                                               ----------------   -----------------
                  Total liabilities                                                262,257,611         235,232,061
                                                                               ----------------   -----------------
Commitments (notes 3 and 12) 

Net worth (note 9):
    Retained income - substantially restricted                                      25,872,605          23,351,343
    Net unrealized gain (loss) on investment securities
       available for sale (note 2)                                                      93,000             (74,000)
                                                                               ----------------   -----------------
                  Total net worth                                                   25,965,605          23,277,343
                                                                               ----------------   -----------------
                  Total liabilities and net worth                             $    288,223,216         258,509,404
                                                                               ================   =================
</TABLE> 

See accompanying notes to consolidated financial statements.

                                      F-2
<PAGE>


                         1ST STATE BANK AND SUBSIDIARY

                       Consolidated Statements of Income

             For the Years Ended September 30, 1998, 1997 and 1996

<TABLE> 
<CAPTION> 
                                                                   1998                1997                1996
                                                             ----------------    ----------------    ---------------- 
<S>                                                          <C>                 <C>                 <C>              
Interest income:                                                                                                      
    Interest and fees on loans                               $     17,184,941          16,167,269          14,620,562 
    Interest and dividends on investments                           2,319,980           2,557,133           2,401,615 
    Overnight deposits                                              1,203,594             336,426             372,900 
                                                             ----------------    ----------------    ---------------- 
                  Total interest income                            20,708,515          19,060,828          17,395,077 
                                                             ----------------    ----------------    ---------------- 
Interest expense:                                                                                                     
    Deposit accounts (note 7)                                      10,330,999           9,743,038           9,450,414 
    Borrowings (note 8)                                               740,439              55,910               3,152 
                                                             ----------------    ----------------    ---------------- 
                  Total interest expense                           11,071,438           9,798,948           9,453,566 
                                                             ----------------    ----------------    ---------------- 
                  Net interest income                               9,637,077           9,261,880           7,941,511
                                                             
Provision for loan losses (note 4)                                   (477,017)           (261,288)           (280,550)
                                                             ----------------    ----------------    ---------------- 
                  Net interest income after provision                                                                 
                     for loan losses                                9,160,060           9,000,592           7,660,961 
                                                             ----------------    ----------------    ---------------- 
Other income:                                                                                                         
    Loan servicing fees (note 3)                                      103,280             108,517             125,440 
    Customer service fees                                             565,693             500,216             411,936 
    Commission from sales of annuities and                                                                            
        mutual funds                                                  436,568             399,058             285,891 
    Real estate operations, net                                        (1,734)             19,808              32,216 
    Mortgage banking income, net                                      436,401             180,809             103,454 
    Securities losses, net (note 2)                                  (246,259)                 --                  -- 
    Other                                                             203,581             259,343             220,039 
                                                             ----------------    ----------------    ---------------- 
                  Total other income                                1,497,530           1,467,751           1,178,976 
                                                             ----------------    ----------------    ---------------- 
Operating expenses:                                                                                                   
    Compensation and related benefits (note 11)                     4,612,183           4,344,800           2,949,424 
    Occupancy and equipment (note 12)                               1,044,147             939,544             845,799 
    Deposit insurance premiums                                        142,015             103,707             464,644 
    Other expenses                                                    975,983           1,084,618             860,034 
    SAIF assessment (note 7)                                               --                  --           1,283,320 
                                                             ----------------    ----------------    ---------------- 
                  Total operating expenses                          6,774,328           6,472,669           6,403,221 
                                                             ----------------    ----------------    ---------------- 
                  Income before income taxes                        3,883,262           3,995,674           2,436,716 
                                                                                                                      
Income taxes (note 10)                                              1,362,000           1,447,100             840,500 
                                                             ----------------    ----------------    ---------------- 
                  Net income                                 $      2,521,262           2,548,574           1,596,216 
                                                             ================    ================    ================ 
</TABLE> 

See accompanying notes to consolidated financial statements.

                                      F-3
<PAGE>
                         1ST STATE BANK AND SUBSIDIARY

                     Consolidated Statements of Net Worth

             For the Years Ended September 30, 1998, 1997 and 1996

<TABLE> 
<CAPTION> 
                                                                                         Net
                                                                                      Unrealized
                                                                                     Gain (Loss) on
                                                                                      Investment
                                                                                      Securities             Total
                                                                  Retained            Available               Net
                                                                   Income              for Sale              Worth
                                                           --------------------   -------------------   -----------------
<S>                                                        <C>                    <C>                   <C>      
Balance at September 30, 1995                              $        19,206,553               (56,000)         19,150,553
Net income                                                           1,596,216                    --           1,596,216
Change in unrealized gain (loss) on investment                                                                        --
    securities available for sale, net of taxes                             --              (118,000)           (118,000)
                                                              -----------------   -------------------   -----------------
Balance at September 30, 1996                                       20,802,769              (174,000)         20,628,769
Net income                                                           2,548,574                    --           2,548,574
Change in unrealized gain (loss) on investment                                                                        --
    securities available for sale, net of taxes                             --               100,000             100,000
                                                              -----------------   -------------------   -----------------
Balance at September 30, 1997                                       23,351,343               (74,000)         23,277,343
Net income                                                           2,521,262                    --           2,521,262
Change in unrealized gain (loss) on investment                                                                        --
    securities available for sale, net of taxes                             --               167,000             167,000
                                                              -----------------   -------------------   -----------------
Balance at September 30, 1998                              $        25,872,605                93,000          25,965,605
                                                              =================   ===================   =================
</TABLE> 


See accompanying notes to consolidated financial statements.

                                      F-4
<PAGE>
                         1ST STATE BANK AND SUBSIDIARY

                     Consolidated Statements of Cash Flows

                 Years ended September 30, 1998, 1997 and 1996

<TABLE> 
<CAPTION> 
                                                                     1998                1997               1996
                                                             ------------------   -----------------  -----------------
<S>                                                          <C>                  <C>                <C>       
Cash flows from operating activities:
    Net income                                               $        2,521,262           2,548,574          1,596,216
    Adjustments to reconcile net income to net cash
       provided (used) by operating activities:
         Provision for loan losses                                      477,017             261,288            280,550
         Depreciation                                                   424,997             270,572            239,130
         Deferred income tax expense (benefit)                         (601,000)            139,000            172,000
         Amortization of premiums and discounts, net                     24,419             (37,116)            (2,112)
         Loan origination fees and unearned discounts
            deferred, net of current amortization                         2,221             104,658            115,328
         Net loss on sale of loans                                      118,633              15,520            122,309
         Gain on sale of other real estate                                   --             (21,288)           (43,319)
         Securities losses, net                                         246,259                  --                 --
         Proceeds from loans held for sale                           27,635,212           9,165,706          9,181,331
         Originations of loans held for sale                        (34,609,326)         (9,765,263)       (11,695,278)
         Decrease (increase) in other assets                           (307,657)            586,726           (227,523)
         Increase in accrued interest receivable                       (250,760)           (133,747)          (101,534)
         Increase in other liabilities                                1,760,298           1,042,830            606,880
                                                                ---------------    ----------------   ----------------
                   Net cash provided by (used in)
                      operating activities                           (2,558,425)          4,177,460            243,978
                                                                ---------------    ----------------   ----------------
Cash flows from investing activities:
    Purchase of FHLB stock                                              (65,300)            (35,500)           (11,900)
    Purchases of investment securities held to
       maturity                                                     (32,614,244)         (6,998,750)       (12,379,167)
    Purchases of investment securities available for
       sale                                                          (2,002,500)                 --         (3,972,438)
    Proceeds from sales of investment securities                                                  
       available for sale                                             2,879,973                  --                 --
    Proceeds from maturities of investment
       securities available for sale                                    588,144           4,000,000          3,000,000
    Proceeds from maturities of investment
       securities held to maturity                                   25,900,000           6,107,200          9,407,696
    Net increase in loans receivable                                   (139,715)        (21,361,303)        (3,211,526)
    Capital expenditures on real estate acquired in
       settlement of loans                                                   --                  --             (6,692)
    Proceeds from disposal of real estate acquired in                         
       settlement of loans                                                   --              22,289            123,478
    Purchases of premises and equipment                              (1,166,544)           (355,006)        (1,127,174)
                                                                ---------------    ----------------   ----------------
                   Net cash used in investing activities             (6,620,186)        (18,621,070)        (8,177,723)
                                                                ---------------    ----------------   ----------------
</TABLE> 

                                                                     (Continued)

                                      F-5

<PAGE>


                          1ST STATE BANK AND SUBSIDIARY

                Consolidated Statements of Cash Flows - Continued

                  Years ended September 30, 1998, 1997 and 1996
<TABLE> 
<CAPTION> 
                                                                      1998                1997               1996
                                                               -----------------   -----------------  -----------------
<S>                                                            <C>                     <C>              <C>            
Cash flows from financing activities:
    Net increase in deposits                                   $      6,353,112          19,633,862          8,937,737
    Increase (decrease) in advance payments by
       borrowers for property taxes and insurance                       (87,860)             45,819            199,939
    Advances from Federal Home Loan Bank                             20,000,000              --              1,000,000
    Repayments of advances from Federal Home
       Loan Bank                                                     (1,000,000)             --                 --
                                                                ----------------   -----------------  -----------------
                   Net cash provided by financing
                      activities                                     25,265,252          19,679,681         10,137,676
                                                                ----------------   -----------------  -----------------
                   Net increase in cash and cash
                      equivalents                                    16,086,641           5,236,071          2,203,931
Cash and cash equivalents at beginning of year                       14,990,413           9,754,342          7,550,411
                                                                ----------------   -----------------  -----------------
                   Cash and cash equivalents at end
                      of year                                  $     31,077,054          14,990,413          9,754,342
                                                                ================   =================  =================
Payments are shown below for the following:
    Interest                                                   $     10,947,338           9,777,417          9,455,792
                                                                ================   =================  =================
    Income taxes                                               $      2,301,000             866,300          1,657,500
                                                                ================   =================  =================
Noncash investing and financing activities:
    Transfer from loans to real estate acquired in
       settlement of loans                                     $         --                  --                 73,468
                                                                ================   =================  =================
    Transfer from loans held for sale to loans
       receivable                                              $         --               2,277,071             --
                                                                ================   =================  =================
</TABLE> 

See accompanying notes to consolidated financial statements.

                                      F-6


<PAGE>
 
                         1ST STATE BANK AND SUBSIDIARY

                  Notes to Consolidated Financial Statements

                       September 30, 1998, 1997 and 1996

                  (With Independent Auditors' Report Thereon)



(1)  SIGNIFICANT ACCOUNTING POLICIES

     (A)  BASIS OF PRESENTATION

          The consolidated financial statements include the accounts of 1st
          State Bank, SSB and its wholly-owned subsidiary, First Capital
          Services Company, LLC (collectively referred to as "the Bank"). First
          Capital Services Company, LLC is engaged primarily in the sale of
          insurance products. Intercompany balances and transactions have been
          eliminated.

     (B)  USE OF ESTIMATES

          The preparation of the consolidated financial statements in conformity
          with generally accepted accounting principles requires management to
          make estimates and assumptions that affect reported amounts of assets
          and liabilities at the date of the financial statements and the
          amounts of income and expenses during the reporting period. Actual
          results could differ from those estimates.

     (C)  CASH AND CASH EQUIVALENTS

          For purposes of reporting cash flows, cash and cash equivalents
          include cash and interest-bearing overnight deposits with the Federal
          Home Loan Bank ("FHLB") of Atlanta. At September 30, 1998 and 1997,
          interest-bearing overnight deposits were $25,558,925 and $7,813,209,
          respectively.

     (D)  INVESTMENT SECURITIES

          Investment securities that the Bank has the positive intent and
          ability to hold to maturity are classified as held to maturity and
          reported at amortized cost. Investment securities held for current
          resale are classified as trading securities and reported at fair
          value, with unrealized gains and losses included in earnings.
          Investment securities not classified either as securities held to
          maturity or trading securities are classified as available for sale
          and reported at fair value, with net unrealized gains and losses net
          of related taxes excluded from earnings and reported as a separate
          component of net worth. The classification of investment securities as
          held to maturity, trading or available for sale is determined at the
          date of purchase.

          Realized gains and losses from sales of investment securities are
          determined based upon the specific identification method. Premiums and
          discounts are amortized as an adjustment to yield over the remaining
          lives of the securities using the level-yield method.

                                                                     (Continued)

                                      F-7
<PAGE>
 
                         1ST STATE BANK AND SUBSIDIARY

                  Notes to Consolidated Financial Statements

                       September 30, 1998, 1997 and 1996

                  (With Independent Auditors' Report Thereon)


          Management periodically evaluates investment securities for other than
          temporary declines in value and records any losses through an
          adjustment to earnings.

     (E)  LOANS HELD FOR SALE

          Loans held for sale are carried at the lower of cost or fair value in
          the aggregate as determined by outstanding commitments from investors
          or current investor yield requirements. Gains and losses on loan sales
          are determined by the difference between the selling price and the
          carrying value of the loans sold.

     (F)  LOANS RECEIVABLE

          Interest on loans, including impaired loans, that are contractually
          ninety days or more past due is generally either charged off or
          reserved through an allowance account. The allowance is established by
          a charge to interest income equal to all interest previously accrued.
          In certain circumstances, interest on loans that are contractually
          ninety days or more past due is not charged off or reserved through an
          allowance account when management determines that the loan is both
          well secured and in the process of collection. If amounts are received
          on loans for which the accrual of interest has been discontinued, a
          determination is made as to whether payments received should be
          recorded as a reduction of the principal balance or as interest income
          depending on management's judgment as to the collectibility of
          principal. The loan is returned to accrual status when, in
          management's judgment, the borrower has demonstrated the ability to
          make periodic interest and principal payments on a timely basis.

     (G)  LOAN ORIGINATION FEES AND RELATED COSTS

          Loan origination fees and certain direct loan origination costs are
          deferred, and the net fee or cost is recognized as an adjustment of
          the loan yield using the level-yield method over the contractual life
          of the related loans.

     (H)  ALLOWANCE FOR LOAN LOSSES

          The allowance for loan losses is established through provisions for
          loan losses charged against income. Loans deemed to be uncollectible
          are charged against the allowance for loan losses, and subsequent
          recoveries, if any, are credited to the allowance.

          Management's evaluation of the adequacy of the allowance is based on a
          review of individual loans, historical loan loss experience, the value
          and adequacy of collateral, and economic conditions in the Bank's
          market area. This evaluation is inherently subjective as it requires
          material estimates, including the amounts and timing of future cash
          flows expected to be

                                      F-8                           (Continued)
<PAGE>
 
                         1ST STATE BANK AND SUBSIDIARY

                  Notes to Consolidated Financial Statements

                       September 30, 1998, 1997 and 1996

                  (With Independent Auditors' Report Thereon)


          received on impaired loans that may be susceptible to significant
          change. Various regulatory agencies, as an integral part of their
          examination process, periodically review the Bank's allowance for loan
          losses. Such agencies may require the Bank to recognize changes to the
          allowance based on their judgments about information available to them
          at the time of their examinations.

          For all specifically reviewed loans for which it is probable that the
          Bank will be unable to collect all amounts due according to the terms
          of the loan agreement, the Bank determines impairment by computing a
          fair value either based on discounted cash flows using the loans'
          initial interest rate or the fair value of the collateral if the loan
          is collateral dependent. Large groups of smaller balance homogenous
          loans that are collectively evaluated for impairment (such as
          residential mortgage and consumer installment loans) are excluded from
          impairment evaluation, and their allowance for loan losses is
          calculated in accordance with the allowance for loan losses policy
          described above.

     (I)  REAL ESTATE ACQUIRED IN SETTLEMENT OF LOANS

          Real estate acquired in settlement of loans by foreclosure or deed in
          lieu of foreclosure is initially recorded at the lower of cost (unpaid
          loan balance plus costs of obtaining title and possession) or fair
          value less estimated costs to sell at the time of acquisition.
          Subsequent costs directly related to development and improvement of
          property are capitalized, whereas costs relating to holding property
          are expensed.

          When the carrying value of real estate exceeds its fair value, less
          cost to sell, an allowance for loss on real estate is established and
          a provision for loss on real estate is charged to other expenses. At
          September 30, 1998 and 1997, the Bank had no real estate acquired in
          settlement of loans.

     (J)  PREMISES AND EQUIPMENT

          Premises and equipment are carried at cost less accumulated
          depreciation. Depreciation is computed generally by the straight-line
          method over the estimated useful lives of the related assets.
          Estimated lives are 15 to 50 years for buildings and 3 to 15 years for
          furniture, fixtures and equipment.

     (K)  INCOME TAXES

          Deferred income taxes are recognized for the future tax consequences
          attributed to differences between the financial statement carrying
          amounts of existing assets and liabilities and their respective tax
          bases. Deferred tax assets and liabilities are measured using enacted
          tax rates in

                                      F-9                            (Continued)
<PAGE>

                         1ST STATE BANK AND SUBSIDIARY

                  Notes to Consolidated Financial Statements

                       September 30, 1998, 1997 and 1996

                  (With Independent Auditors' Report Thereon)


          effect for the year in which the temporary differences are expected to
          be recovered or settled. Deferred tax assets are reduced by a
          valuation allowance if it is more likely than not that the tax
          benefits will not be realized. The effect on deferred tax assets and
          liabilities of a change in tax rates is recognized in income in the
          period that includes the enactment date.

     (L)  RECLASSIFICATIONS

          Certain amounts in the 1997 and 1996 consolidated financial statements
          have been reclassified to conform with the presentation adopted in
          1998. Such reclassifications did not change net income or net worth as
          previously reported.

(2)  INVESTMENT SECURITIES

     Investment securities consist of the following:

<TABLE>
<CAPTION>
                                                      AMORTIZED           UNREALIZED          UNREALIZED             FAIR
                                                         COST               GAINS               LOSSES               VALUE      
                                                   ---------------    ----------------    ----------------     ---------------- 
     <S>                                          <C>                 <C>                 <C>                  <C>              
                SEPTEMBER 30, 1998                                                                                              
     Held to maturity:                                                                                                          
          U.S. Government and agency                                                                                            
              securities                          $     30,087,456             219,742                  --           30,307,198 
          Collateralized mortgage                                                                                               
              obligations                                  107,638                 611                  --              108,249 
                                                   ---------------    ----------------    ----------------     ----------------  
                          Total                   $     30,195,094             220,353                  --           30,415,447 
                                                   ===============    ================    ================     ================ 
     Available for sale:                                                                                                        
          U.S. Government and                                                                                                   
              agency securities                          4,001,142              42,363                (232)           4,043,273 
          Marketable equity securities                   3,993,081              13,120                  --            4,006,201 
          FHLMC mortgage-backed                                                                                                 
              securities                                   648,029              13,550                  --              661,579 
          GNMA mortgage-backed                     
              securities                                 1,063,277              83,450                  --            1,146,727 
                                                   ---------------    ----------------    ----------------     ----------------  
                          Total                   $      9,705,529             152,483                (232)           9,857,780 
                                                   ===============    ================    ================     ================  
</TABLE>

                                    F-10                            (Continued)
<PAGE>
 
                         1ST STATE BANK AND SUBSIDIARY

                  Notes to Consolidated Financial Statements

                       September 30, 1998, 1997 and 1996

                  (With Independent Auditors' Report Thereon)


<TABLE>
<CAPTION>
                                           AMORTIZED           UNREALIZED          UNREALIZED              FAIR
                                              COST               GAINS               LOSSES               VALUE
                                        ----------------    ----------------    ----------------     ----------------
<S>                                     <C>                 <C>                 <C>                  <C>              
      SEPTEMBER 30, 1997                                                                                                   
Held to maturity:                                                                                                          
   U.S. Government and agency                                                                                           
    securities                           $    23,337,997              82,229             (26,750)          23,393,476 
   Collateralized mortgage                                                                                                    
    obligations                                  143,513               2,781                  --              146,294 
                                         ---------------    ----------------    ----------------     ----------------  
                    Total                $    23,481,510              85,010             (26,750)          23,539,770 
                                         ===============    ================    ================     ================ 
Available for sale:                                                                                                        
   U.S. Government and                                                                                                   
    agency securities                          3,993,052              18,949                  --            4,012,001 
   Marketable equity securities                4,262,331                  --            (301,949)           3,960,382 
   FHLMC mortgage-backed                                                                                                      
    securities                                 1,507,153              60,679              (3,499)           1,564,333 
   GNMA mortgage-backed                                                                                                       
    securities                                 1,650,088             104,251                  --            1,754,339 
   FNMA mortgage-backed                                                                                                       
    securities                                    28,540                 182                  --               28,722 
                                         ---------------    ----------------    ----------------     ----------------  
               Total                     $    11,441,164             184,061            (305,448)          11,319,777   
                                         ===============    ================    ================     ================  
</TABLE>

Following is a summary of investments in debt securities by maturity at
September 30, 1998.  Marketable equity securities, mortgage-backed securities
and collateralized mortgage obligations do not have single maturity dates and
are not included below.

<TABLE>
<CAPTION>
                                                                        AMORTIZED              FAIR      
                                                                           COST               VALUE      
                                                                    ----------------    ---------------- 
<S>                                                                 <C>                 <C>              
Held to maturity:                                                                                        
  Within one year                                                   $      3,992,563           4,014,606 
  After one but within five years                                         15,471,247          15,599,483 
  After five but within ten years                                          9,623,646           9,687,469 
  After ten years                                                          1,000,000           1,005,640 
                                                                    ----------------    ----------------  
               Total                                                $     30,087,456          30,307,198 
                                                                    ================    ================ 
Available for sale:                                                                                      
  After one but within five years                                   $      3,001,142           3,043,505 
  After five but within ten years                                          1,000,000             999,768 
                                                                    ----------------    ----------------  
               Total                                                $      4,001,142           4,043,273 
                                                                    ================    ================ 
  </TABLE>

                                      F-11                           (Continued)
<PAGE>

                         1ST STATE BANK AND SUBSIDIARY

                  Notes to Consolidated Financial Statements

                       September 30, 1998, 1997 and 1996

                  (With Independent Auditors' Report Thereon)


     During the year ended September 30, 1998, the Bank recognized gross gains
     on the sale of investment securities available for sale of approximately
     $23,000. There were no sales in 1997 and 1996. The Bank also recognized a
     loss of approximately $269,000 on the write-down of marketable equity
     securities for an other than temporary decline in value during the year
     ended September 30, 1998.

     At September 30, 1998, U.S. Government securities with an amortized cost of
     approximately $2,000,000 were pledged as collateral for certain deposit
     accounts.


(3)  LOANS RECEIVABLE

     Loans receivable are summarized as follows:

<TABLE>
<CAPTION>
                                                                                        SEPTEMBER 30,            
                                                                                  1998                 1997      
                                                                           ----------------     ---------------- 
     <S>                                                                   <C>                  <C>              
     Real estate loans:                                                                                          
          One-to-four family residential                                   $    100,891,490          108,399,580 
          Commercial real estate and other properties                            38,763,299           34,333,514 
          Home equity and property improvement                                   16,877,066           18,140,649 
          Construction loans                                                     18,571,550           12,582,348 
                                                                           ----------------     ---------------- 
                         Total real estate loans                                175,103,405          173,456,091 
                                                                           ----------------     ---------------- 
     Other loans:                                                                                                
          Commercial                                                             25,189,613           22,869,834 
          Consumer                                                                6,309,951            5,354,150 
                                                                           ----------------     ---------------- 
                         Total other loans                                       31,499,564           28,223,984 
                                                                           ----------------     ---------------- 
     Less:                                                                                                       
          Loans in process                                                       (6,446,324)          (1,660,110)
          Net deferred loan origination fees                                       (146,595)            (144,374)
                                                                           ----------------     ---------------- 
          Net loans receivable before allowance for loan losses                 200,010,050          199,875,591 
          Allowance for loan losses                                              (3,227,775)          (2,753,793)
                                                                           ----------------     ---------------- 
                         Loans receivable, net                             $    196,782,275          197,121,798 
                                                                           ================     ================  
</TABLE>

     At September 30, 1998 and 1997 and during the years then ended there are no
     loans considered to be impaired.

                                       F-12                         (Continued)
<PAGE>
 
                         1ST STATE BANK AND SUBSIDIARY

                  Notes to Consolidated Financial Statements

                       September 30, 1998, 1997 and 1996

                  (With Independent Auditors' Report Thereon)


     The Bank grants residential, residential construction, commercial real
     estate, home equity and other loans to customers primarily throughout its
     market area of Alamance County which includes the cities of Burlington,
     Mebane and Graham. As reflected in the summary of loans receivable at
     September 30, 1998, the largest component of the Bank's loan portfolio
     consists of lower-risk, one-to-four family residential loans. The higher
     risk components of the loan portfolio consist of real estate construction
     loans, commercial real estate loans and commercial loans for which
     repayment is dependent on the current real estate market and general
     economic conditions. The consumer portfolio generally consists of smaller
     loans to individuals in the Bank's primary market area and can also be
     affected by general economic conditions.

     The Bank's nonaccrual loans amount to approximately $263,000, $259,000 and
     $288,000 at September 30, 1998, 1997 and 1996, respectively. If the Bank's
     nonaccrual loans had been current in accordance with their original terms,
     gross interest income of approximately $10,100, $27,300 and $25,800 would
     have been recorded for the years ended September 30, 1998, 1997 and 1996,
     respectively. Interest income on these loans included in net income was
     approximately $15,000, $15,700 and $12,300 for 1998, 1997 and 1996,
     respectively.

     Loans serviced for others at September 30, 1998 and 1997 were approximately
     $37,000,000 and $43,000,000, respectively. Mortgage servicing rights were
     not material for any of the periods presented.

     The Bank offers mortgage and consumer loans to its officers, directors, and
     employees for the financing of their personal residences and for other
     personal purposes. The Bank also offers commercial loans to companies
     affiliated with directors. These loans are made in the ordinary course of
     business and, in management's opinion, are made on substantially the same
     terms, including interest rates and collateral, prevailing at the time for
     comparable transactions with other persons and companies. Management does
     not believe these loans involve more than the normal risk of collectibility
     or present other unfavorable features, except for certain loans totaling
     approximately $3.5 million to a company affiliated with a director. At
     September 30, 1998, such loans were current with respect to their payment
     terms and except for the waiver of certain debt covenants by the Bank, were
     performing in accordance with the related loan agreements. Based on an
     analysis of the affiliated company's current financial statements,
     management has concerns that the borrower may have difficulty in complying
     with the present loan repayment terms on an ongoing basis.

                                    F-13                            (Continued)
<PAGE>

                         1ST STATE BANK AND SUBSIDIARY

                  Notes to Consolidated Financial Statements

                       September 30, 1998, 1997 and 1996

                  (With Independent Auditors' Report Thereon)


The following is a summary of the activity of loans outstanding to certain
executive officers, directors and their affiliates for the year ended September
30, 1998:

<TABLE>
<S>                                                     <C>
Balance at September 30, 1997                           $       7,495,243
New loans                                                       1,412,420
Repayments                                                      1,387,958
                                                        -----------------
Balance at September 30, 1998                           $       7,519,705
                                                        =================
</TABLE>

The Bank is a party to financial instruments with off-balance sheet risk
including commitments to extend credit under existing lines of credit and
commitments to sell loans. These instruments involve, to varying degrees,
elements of credit and interest rate risk in excess of the amount recognized in
the consolidated balance sheets.

Off-balance sheet financial instruments whose contract amount represents credit
and interest rate risk are summarized as follows:

<TABLE>
<CAPTION>
                                                                                     SEPTEMBER 30,
                                                                              1998                   1997
                                                                      -------------------    -------------------
<S>                                                                   <C>                    <C>
Commitments to originate new loans                                     $        6,650,700              3,860,732
Commitments to originate new loans held for sale                                  833,411                224,863
Unfunded commitments to extend credit under existing equity
  line and commercial lines of credit                                          40,444,057             34,593,971
Commercial letters of credit                                                      505,000                874,709
Commitments to sell loans held for sale                                         1,863,591                684,438
</TABLE>

Commitments to originate new loans or to extend credit are agreements to lend to
a customer as long as there is no violation of any condition established in the
contract. Commitments generally have fixed expiration dates or other termination
clauses and may require payment of a fee. Since many of the commitments are
expected to expire without being drawn upon, the total commitment amounts do not
necessarily represent future cash requirements. The Bank evaluates each
customer's creditworthiness on a case-by-case basis. The amount of collateral
obtained, if deemed necessary by the Bank upon extension of credit, is based on
management's credit evaluation of the borrower. The Bank's commitments to extend
credit under existing lines of credit relate principally to home equity lines of
credit which are secured by the borrower's primary residence.

Commitments to sell loans held for sale are agreements to sell loans to a third
party at an agreed upon price. At September 30, 1998, the aggregate fair value
of the commitments exceeded the cost of the loans to be sold.

                                   F-14                            (Continued)
<PAGE>

                         1ST STATE BANK AND SUBSIDIARY

                  Notes to Consolidated Financial Statements

                       September 30, 1998, 1997 and 1996

                  (With Independent Auditors' Report Thereon)

 
(4)  ALLOWANCE FOR LOAN LOSSES

     The following is a summary of the activity in the allowance for loan
     losses:

<TABLE>
<CAPTION>
                                                                    YEARS ENDED SEPTEMBER 30,
                                                           1998                 1997                 1996
                                                    ----------------     ----------------     ----------------
     <S>                                            <C>                  <C>                  <C>
     Balance at beginning of year                    $     2,753,793            2,495,677            2,222,765      
     Provision for loan losses                               477,017              261,288              280,550      
                                                                                                                    
     Charge-offs                                              (3,731)              (7,548)             (12,477)     
     Recoveries                                                  696                4,376                4,839      
                                                    ----------------     ----------------     ----------------   
             Net charge-offs                                  (3,035)              (3,172)              (7,638)
                                                    ----------------     ----------------     ----------------   
             Balance at end of year                  $     3,227,775            2,753,793            2,495,677
                                                    ================     ================     ================ 
</TABLE>

(5)  INVESTMENT IN FHLB STOCK

     As a member of the FHLB of Atlanta, the Bank is required to maintain an
     investment in the stock of the FHLB. This stock is carried at cost since it
     has no quoted fair value. See also note 8.

(6)  PREMISES AND EQUIPMENT

     Premises and equipment consist of the following:

<TABLE>
<CAPTION>
                                                                                 SEPTEMBER 30,
                                                                           1998                 1997
                                                                    ----------------     ----------------
     <S>                                                           <C>                  <C>
     Land                                                           $     2,231,450            2,231,450
     Building and improvements                                            5,166,911            5,166,911
     Furniture and equipment                                              3,987,664            2,821,845
                                                                   ----------------     ---------------- 
                                                                         11,386,025           10,220,206
     Less accumulated depreciation                                       (3,872,678)          (3,448,406)
                                                                   ----------------     ---------------- 
                 Total                                              $     7,513,347            6,771,800
                                                                   ================     ================
</TABLE>

                                    F-15                            (Continued)
<PAGE>
 
                         1ST STATE BANK AND SUBSIDIARY

                  Notes to Consolidated Financial Statements

                       September 30, 1998, 1997 and 1996

                  (With Independent Auditors' Report Thereon)


(7)  DEPOSIT ACCOUNTS

     A comparative summary of deposit accounts follows:

<TABLE>
<CAPTION>
                                                                  SEPTEMBER 30, 1998
                                                        ------------------------------------- 
                                                                                 WEIGHTED    
                                                             BALANCE           AVERAGE RATE  
                                                        ----------------    ----------------- 
    <S>                                                 <C>                 <C> 
    Transactions accounts:                                                        
      Noninterest bearing accounts                      $      8,623,397              -- %
      Interest bearing accounts:                                                              
          Checking accounts                                   25,080,180             2.29%
          Money market accounts                               13,238,368             3.93%
    Passbook and statement savings accounts                   28,091,013             2.84%
    Certificates of deposit                                  160,660,757             5.28%
                                                        ----------------    ----------------- 
               Total                                    $    235,693,715             4.40%
                                                        ================    ================= 
<CAPTION> 
                                                                  SEPTEMBER 30, 1997
                                                        ------------------------------------- 
                                                                                 WEIGHTED    
                                                             BALANCE           AVERAGE RATE  
                                                        ----------------    ----------------- 
    <S>                                                 <C>                 <C> 
    Transactions accounts:                                                        
      Noninterest bearing accounts                      $      6,546,032               -- %
      Interest bearing accounts:                                                              
          Checking accounts                                   24,149,622              2.32%
          Money market accounts                               11,117,680              3.64%
    Passbook and statement savings accounts                   27,699,834              2.84%
    Certificates of deposit                                  159,827,435              5.33%
                                                        ----------------    -----------------
               Total                                    $    229,340,603              4.48%
                                                        ================    ================= 
</TABLE>    
                                                                             
     Time deposits with balances of $100,000 or greater totaled approximately  
     $29,700,000 and $29,579,000 at September 30, 1998 and 1997, respectively. 

                                     F-16                            (Continued)
<PAGE>
 
                         1ST STATE BANK AND SUBSIDIARY

                  Notes to Consolidated Financial Statements

                       September 30, 1998, 1997 and 1996

                  (With Independent Auditors' Report Thereon)

                                                                             
     At September 30, 1998, the scheduled maturities of certificate accounts
     were as follows:

<TABLE>
     <S>                                               <C>
     Year ending September 30,
            1999                                       $   116,528,391
            2000                                            25,212,621
            2001                                            10,643,247
            2002                                             4,052,541
            2003                                             4,188,260
            2004                                                35,697
                                                       ---------------

           Total                                       $   160,660,757
                                                       ===============
</TABLE>

     Interest expense on deposit accounts is summarized below:

<TABLE>
<CAPTION>
                                                                YEARS ENDED SEPTEMBER 30,
                                                        1998             1997             1996
                                                   --------------    -------------   --------------
     <S>                                           <C>               <C>             <C>
     Interest-bearing transaction accounts          $   1,004,155          898,330          770,911
     Passbook and statement savings accounts              797,752          815,816          827,802
     Certificate accounts                               8,529,092        8,028,892        7,851,701
                                                    --------------   -------------    -------------- 
             Total                                  $  10,330,999        9,743,038        9,450,414
                                                    ==============   =============    ============== 
</TABLE>

     On September 30, 1996, Congressional legislation was passed allowing a
     special assessment to be levied by the FDIC to recapitalize the Savings
     Association Insurance Fund ("SAIF"). The special assessment was based on
     the level of SAIF deposits a financial institution had as of March 31, 1995
     subject to a 20% reduction for certain qualifying deposits. The Bank's
     special assessment in 1996 totaled $1,283,320.


(8)  ADVANCES FROM FEDERAL HOME LOAN BANK OF ATLANTA

     Advances from the FHLB of Atlanta at September 30, 1998 and 1997 totaled
     $20,000,000 and $1,000,000, respectively, at an interest rate of 5.39% and
     5.57%, respectively. These advances will mature on February 13, 2008.

     At September 30, 1998 and 1997, the Bank had pledged all of its stock in
     the FHLB (see note 5) and entered into a security agreement with a blanket
     floating lien pledging all of its real estate loans to secure potential
     borrowings. Under an agreement with the FHLB, the Bank must have
     unencumbered collateral with principal balances, when discounted at 75% of
     the unpaid principal, at least equal to 100% of the Bank's FHLB advances.

                                     F-17                            (Continued)
<PAGE>
 
                         1ST STATE BANK AND SUBSIDIARY

                  Notes to Consolidated Financial Statements

                       September 30, 1998, 1997 and 1996

                  (With Independent Auditors' Report Thereon)


     Interest expense on FHLB advances during the years ended September 30,
     1998, 1997 and 1996 was $740,439, $55,910 and $3,152 respectively.


(9)  NET WORTH AND REGULATORY MATTERS

     At September 30, 1998, retained income-substantially restricted included
     approximately $4,188,000 for which no provision for Federal income tax has
     been made. This amount represents an allocation of income to bad debt
     deductions for income tax purposes only. Reduction of such an amount for
     purposes other than to absorb bad debt losses could create taxable income
     in certain remote instances, which would be subject to the then current
     corporate income tax rate.

     The Bank is regulated by the Federal Deposit Insurance Corporation ("FDIC")
     and the Administrator, Savings Institutions Division, North Carolina
     Department of Commerce ("the Administrator"). The Bank must comply with the
     capital requirements of the FDIC and the Administrator. The FDIC requires
     the Bank to maintain minimum ratios of Tier I capital to risk-weighted
     assets and total capital to risk-weighted assets of 4% and 8%,
     respectively. To be "well capitalized," the FDIC requires ratios of Tier I
     capital to risk-weighted assets and total capital to risk-weighted assets
     of 6% and 10%, respectively. Tier I capital consists of total net worth
     calculated in accordance with generally accepted accounting principles less
     intangible assets, and total capital is comprised of Tier I capital plus
     certain adjustments, the only one of which applicable to the Bank is the
     allowance for loan losses. Risk-weighted assets reflect the Bank's on- and
     off-balance sheet exposures after such exposures have been adjusted for
     their relative risk levels using formulas set forth in FDIC regulations.
     The Bank is also subject to a leverage capital requirement, which calls for
     a minimum ratio of Tier I capital (as defined above) to quarterly average
     total assets of 3%, and a ratio of 5% to be "well capitalized." The
     Administrator requires a net worth equal to at least 5% of assets.

     As summarized below, at September 30, 1998 and 1997, the Bank was in
     compliance with all of the aforementioned capital requirements.

     At September 30, 1998, the FDIC categorized the Bank as "well capitalized"
     under the regulatory framework for prompt corrective action. There are no
     events or conditions since the notification that management believes have
     changed the Bank's category.

                                     F-18                           (Continued)
<PAGE>
 
                         1ST STATE BANK AND SUBSIDIARY

                  Notes to Consolidated Financial Statements

                       September 30, 1998, 1997 and 1996

                  (With Independent Auditors' Report Thereon)


     As of September 30:

<TABLE>
<CAPTION>
                                                                                               MINIMUM RATIOS
                                                                                    ------------------------------------
                                                                                                          TO BE "WELL
                                                                                      FOR CAPITAL       CAPITALIZED" FOR
                                         CAPITAL AMOUNT              RATIO              ADEQUACY       PROMPT CORRECTIVE
                                      ---------------------  --------------------                
                                         1998       1997        1998      1997          PURPOSES        ACTION PURPOSES
                                      ---------  ----------  ---------  ---------   ---------------    -----------------
                                          (in thousands)
     <S>                              <C>        <C>         <C>        <C>         <C>                <C> 
     Tier I Capital (to risk- 
          weighted assets)            $ 25,873     23,049       14.53%    14.05%          4.00%                 6.00%     
     Total Capital - Tier II                                                                                              
          (to risk-weighted                                                                                               
          assets)                       28,112     25,108       15.78%    15.30%          8.00%                10.00%     
     Leverage - Tier I capital                                                                                            
          (to average assets)           25,873     23,049        9.13%     9.02%          4.00%                 5.00%     
     Total Capital - (to                                                                                                  
          fourth quarter                                                                                                  
          average assets)               28,112     25,108        9.92%     9.82%          3.00%                 5.00%     
</TABLE>

(10) INCOME TAXES

     Components of income tax expense (benefit) consist of the following:

<TABLE>
<CAPTION>
                                                               YEAR ENDED SEPTEMBER 30,
                                                   1998                 1997                1996
                                             ----------------     ----------------    ----------------
     <S>                                     <C>                  <C>                 <C> 
     Currently payable:
          Federal                             $  1,804,000              1,221,100             657,500 
          State                                    159,000                 87,000              11,000 
                                               ------------         --------------      --------------
                                                 1,963,000              1,308,100             668,500 
                                               ------------         --------------      --------------
                                                                                                      
     Deferred:                                                                                        
          Federal                                 (486,000)               139,000             172,000 
          State                                   (115,000)                    --                  -- 
                                               ------------         --------------      --------------
                                                  (601,000)               139,000             172,000 
                                               ------------         --------------      --------------
               Total                          $  1,362,000              1,447,100             840,500 
                                               ============         ==============      ==============
</TABLE>

     Other assets include current income taxes receivable of $251,000 at
     September 30, 1998. Other liabilities include current income taxes payable
     of $76,000 at September 30, 1997. 

                                     F-19                            (Continued)
<PAGE>
 
                         1ST STATE BANK AND SUBSIDIARY

                  Notes to Consolidated Financial Statements

                       September 30, 1998, 1997 and 1996

                  (With Independent Auditors' Report Thereon)


   A reconciliation of reported income tax expense for the years ended September
   30 1998 and 1997, to the amount of the income tax expense computed by
   multiplying income before income taxes by the statutory federal income tax
   rate of 34% follows:

<TABLE> 
<CAPTION> 
                                                   1998       1997       1996
                                                 ---------  ---------  ---------
<S>                                            <C>          <C>        <C> 
Income tax expense at statutory rate           $ 1,320,000  1,359,000    828,500
Increase in income taxes resulting from:                        
  State income taxes, net of federal benefit        29,000     57,000      7,000
  Other                                             13,000     31,100      5,000
                                                 ---------  ---------  ---------
                      Income tax expense       $ 1,362,000  1,447,100    840,500
                                                 =========  =========  =========
</TABLE> 

The significant components of deferred tax assets (liabilities) which are 
included in other assets, at September 30, 1998 and 1997, respectively, are:

<TABLE>
<CAPTION>
                                                                                       1998                 1997
                                                                                ----------------     ----------------
<S>                                                                            <C>                   <C>          
Deferred tax assets:
     Allowance for loan losses                                                 $       1,079,000              851,000
     Loan fees deferred for financial reporting, net                                      52,000               49,000
     Deferred compensation                                                               750,000              369,000
     Other than temporary declines in value of
         securities available for sale                                                    97,000                   --
     Unrealized gains on investments securities available for sale                            --               47,000
     Other                                                                                 3,000                4,000
                                                                                ----------------     ---------------- 
                      Total gross deferred tax assets                                  1,981,000            1,320,000
                                                                                ----------------     ---------------- 
                      Less valuation allowance                                                --                   --
                                                                                ----------------     ---------------- 
                      Deferred tax assets net of valuation allowance                   1,981,000            1,320,000
                                                                                ----------------     ---------------- 
Deferred tax liabilities:
     Depreciable basis of fixed assets                                                  (288,000)            (270,000)
     Tax basis of FHLB stock                                                            (179,000)            (168,000)
     Loan fees                                                                          (231,000)            (158,000)
     Unrealized losses on investment securities available for sale                       (59,000)                  --
     Other                                                                               (17,000)             (12,000)
                                                                                ----------------     ---------------- 
                      Total gross deferred tax liabilities                              (774,000)            (608,000)
                                                                                ----------------     ---------------- 
                      Net deferred tax asset                                   $       1,207,000              712,000
                                                                                ================     ================
</TABLE>

                                     F-20                            (Continued)
<PAGE>
 
                         1ST STATE BANK AND SUBSIDIARY

                  Notes to Consolidated Financial Statements

                       September 30, 1998, 1997 and 1996

                  (With Independent Auditors' Report Thereon)


     There is no valuation allowance for deferred tax assets as it is
     management's contention that realization of the deferred tax assets is more
     likely than not based upon the Bank's history of taxable income and
     estimates of future taxable income.

     The Bank is permitted under the Internal Revenue Code to deduct an annual
     addition to a reserve for bad debts in determining taxable income, subject
     to certain limitations. This addition differs significantly from the
     provisions for loan and real estate owned losses for financial reporting
     purposes. Under FASB 109, the Bank is not required to provide a deferred
     tax liability for the tax effect of additions to the tax bad debt reserve
     through 1987, the base year. Retained income at September 30, 1998,
     includes approximately $4,188,000 for which no provision for federal income
     tax has been made. These amounts represent allocations of income to bad
     debt deductions for tax purposes only. Reductions of such amounts for
     purposes other than tax bad debt losses could create income for tax
     purposes in certain remote instances, which would be subject to the then
     current corporate income tax rate.


(11) RETIREMENT PLANS

     The Bank has two defined contribution retirement plans covering
     substantially all of its employees. Retirement costs are funded as accrued.
     Contributions to the plans are determined based upon specified percentages
     of annual salaries. Retirement expense for the years ended September 30,
     1998, 1997, and 1996 was approximately $191,000, $207,000 and $215,000,
     respectively.

     Directors and certain executive officers participate in a deferred
     compensation plan which was approved by the Board of Directors on September
     24, 1997. This plan generally provides for fixed payments beginning at age
     62. The plan provides for past service credits of up to nine years, with
     vesting of 100% and 60% at September 30, 1998 and 1997, respectively. In
     addition, an annual amount will be credited to the participants accounts in
     subsequent years which will be fully vested at all times. In future years,
     directors may elect to defer directors' fees and executive officers may
     defer 25% of their salary and 100% of bonus compensation. The expense
     related to these plans for the years ended September 30, 1998 and 1997 was
     $986,663 and $1,085,000, respectively, and is included in compensation
     expense. The related liabilities at September 30, 1998 and 1997 of
     approximately $1,085,000 and $2,072,000, respectively, are included in
     other liabilities.

                                     F-21
<PAGE>
 
                         1ST STATE BANK AND SUBSIDIARY

                  Notes to Consolidated Financial Statements

                       September 30, 1998, 1997 and 1996

                  (With Independent Auditors' Report Thereon)


(12) LEASING ARRANGEMENTS

     Rental expense was approximately $33,000 and $35,000 for the years ended
     September 30, 1998 and 1997, respectively. All leases are accounted for as
     operating leases. Minimum annual rents under noncancelable operating leases
     with remaining terms in excess of one year at September 30, 1998 are as
     follows:

<TABLE>
<CAPTION>
                                                      OFFICE    
                                                    PROPERTIES   
                                                  -------------- 
     <S>                                         <C>           
     Year ending September 30,                                 
                 1999                            $      15,000
                 2000                                   17,250
                 2001                                   18,000
                 2002                                   18,000
                 2003                                   18,000
                Thereafter                             127,500
                                                  -------------- 
                 Total                           $     213,750 
                                                  ============== 
</TABLE>

(13) FAIR VALUE OF FINANCIAL INSTRUMENTS

     SFAS No. 107, "Disclosures about Fair Value of Financial Instruments,"
     requires a company to disclose the fair value of its financial instruments,
     whether or not recognized in the balance sheet, where it is practical to
     estimate that value.

     The fair value estimates are made at a specific point in time based on
     relevant market information about the financial instrument. These estimates
     do not reflect any premium or discount that could result from offering for
     sale at one time the Bank's entire holding of a particular financial
     instrument. In cases where quoted market prices are not available, fair
     value estimates are based on judgments regarding current economic
     conditions, risk characteristics of various financial instruments, and
     other factors. These estimates are subjective in nature and involve
     uncertainties and matters of significant judgment and, therefore, cannot be
     determined with precision. Changes in assumptions could significantly
     affect the estimates. In addition, the tax ramifications related to the
     realization of the unrealized gains and losses can have a significant
     effect on fair value estimates and have not been considered in the
     estimates. Finally, the fair value estimates presented herein are based on
     pertinent information available to management as of September 30, 1998 and
     1997, respectively. Such amounts have not been comprehensively revalued for
     purposes of these financial statements since those dates and, therefore,
     current estimates of fair value may differ significantly from the amounts
     presented herein.

                                     F-22                            (Continued)
<PAGE>
 
                         1ST STATE BANK AND SUBSIDIARY

                  Notes to Consolidated Financial Statements

                       September 30, 1998, 1997 and 1996

                  (With Independent Auditors' Report Thereon)


     The following methods and assumptions were used by the Bank in estimating
     its fair value disclosures for financial instruments:

     (A)  CASH AND CASH EQUIVALENTS

          The carrying amounts reported in the balance sheet for cash and cash
          equivalents approximate those assets' fair values.

     (B)  INVESTMENT SECURITIES

          Fair values were based on quoted market prices, where available. If
          quoted market prices were not available, fair values were based on
          quoted market prices of comparable instruments.

     (C)  LOANS RECEIVABLE

          The carrying values of variable-rate loans and other loans with short-
          term characteristics were considered to approximate the fair values.
          For other loans, the fair values were calculated using discounted cash
          flow analyses, using interest rates currently being offered for loans
          with similar terms and credit quality.

     (D)  DEPOSIT ACCOUNTS

          The fair value of deposits with no stated maturity, such as
          noninterest-bearing demand deposits, NOW, passbook, and money market
          deposits, was, by definition, equal to the amount payable on demand as
          of September 30, 1998 and 1997, respectively. The fair value of
          certificates of deposit was estimated using discounted cash flow
          analyses, using interest rates currently offered for deposits of
          similar remaining maturities.

     (E)  ADVANCES FROM THE FHLB

          The fair value of advances from the FHLB was estimated using
          discounted cash flow analyses, using interest rates currently offered
          for advances of similar remaining maturities.

                                      F-23                           (Continued)
<PAGE>
 
                         1ST STATE BANK AND SUBSIDIARY

                  Notes to Consolidated Financial Statements

                       September 30, 1998, 1997 and 1996

                  (With Independent Auditors' Report Thereon)


The estimated fair values of financial instruments are as follows:

<TABLE>
<CAPTION>
                                                                            SEPTEMBER 30, 1998
                                                                  ------------------------------------
                                                                       CARRYING           ESTIMATED
                                                                        VALUE             FAIR VALUE
                                                                  ----------------    ----------------
<S>                                                              <C>                  <C> 
Financial Assets:
     Cash and cash equivalents                                   $      31,077,054          31,077,054
     Investment securities                                              40,052,874          40,273,227
     Loans held for sale                                                 7,539,919           8,192,660
     Loans receivable, net of allowance for loan losses                196,782,275         201,783,429
     Federal Home Loan Bank stock                                        1,346,500           1,346,500
                                                                  ================    ================
                                                                 
Financial Liabilities:                                           
     Deposit accounts                                            $     235,693,715         235,904,989
     Advances from the Federal Home Loan Bank                           20,000,000          21,038,755
                                                                  ================    ================
 <CAPTION> 
                                                                            SEPTEMBER 30, 1997
                                                                  ------------------------------------
                                                                       CARRYING           ESTIMATED
                                                                        VALUE             FAIR VALUE
                                                                   ----------------    ----------------
<S>                                                              <C>                   <C> 
Financial Assets:
     Cash and cash equivalents                                   $      14,990,413          14,990,413
     Investment securities                                              34,801,287          34,859,547
     Loans held for sale                                                   684,438             684,438
     Loans receivable, net of allowance for loan losses                197,121,798         197,864,510
     Federal Home Loan Bank stock                                        1,281,200           1,281,200
                                                                  ================    ================
                                                                 
Financial Liabilities:                                           
     Deposit accounts                                            $     229,340,603         229,704,672
     Advances from the Federal Home Loan Bank                            1,000,000           1,000,000
                                                                  ================    ================
</TABLE>

At September 30, 1998 and 1997, the Bank had outstanding commitments to
originate new loans and to extend credit. These off-balance sheet financial
instruments were exercisable at the market rate prevailing at the date the
underlying transaction will be completed and, therefore, they were deemed to
have no current fair market value.

SFAS 107 excludes certain financial instruments and all non-financial
instruments from its disclosure requirements. The disclosures also do not
include premises and equipment and certain intangible assets, such as customer
relationships. Accordingly, the aggregate fair value amounts presented above do
not represent the underlying value of the Bank.

                                     F-24
<PAGE>
 
                                   GLOSSARY

APB                      Accounting Principles Board

Administrator            Administrator, Savings Institutions Division, North
                         Carolina Department of Commerce

Bank                     1st State Bank, a North Carolina-chartered mutual
                         savings bank

Bank Conversion          The conversion of 1st State Bank, Inc. from a North
                         Carolina-chartered stock savings bank to a North
                         Carolina-chartered commercial bank

BIF                      Bank Insurance Fund of the FDIC

Commission               State Banking Commission of North Carolina, as well as
                         the State Banking Commissioner of North Carolina, whose
                         powers are exercised under the supervision of the
                         Commission

Community Offering       Offering for sale to certain members of the general
                         public of any shares of common stock not subscribed for
                         in the Subscription Offering, including the possible
                         offering of common stock in a Syndicated Community
                         Offering

Company                  1st State Bancorp, Inc., a Virginia corporation

Conversion               The Stock Conversion and the Bank Conversion

Converted Bank           As the case may be, 1st State Bank, Inc., a North
                         Carolina-chartered stock savings bank to be formed upon
                         the consummation of the Stock Conversion or 1st State
                         Bank, a North Carolina-chartered commercial bank to be
                         formed upon consummation of the Bank Conversion
 
Eligible Account         Savings account holders of 1st State Bank with account
Holders                  balances of at least $50.00 as of the close of business
                         on December 31, 1994
 
ESOP                     Employee Stock Ownership Plan of the Company

Estimated                Estimated pro forma market value of the Converted Bank
Valuation Range          ranging from $25.5 million to $34.5 million
 
Exchange Act             Securities Exchange Act of 1934, as amended
 
Expiration Date          12:00 Noon, Eastern Time, on ___________, 1999

FASB                     Financial Accounting Standards Board

FDIC                     Federal Deposit Insurance Corporation

Federal Reserve Board    The Board of Governors of the Federal Reserve System

Ferguson                 Ferguson & Company

                                      A-1
<PAGE>
 
FHLB                     Federal Home Loan Bank

FHLMC                    Federal Home Loan Mortgage Corporation

FNMA                     Federal National Mortgage Association

Foundation               1st State Bank Foundation, Inc., a North Carolina
                         nonstock corporation dedicated to charitable and
                         community service causes within our market area

GNMA                     Government National Mortgage Association

IRA                      Individual retirement account or arrangement

IRS                      Internal Revenue Service

MRP                      Management recognition plan to be adopted no earlier
                         than six months after the conversion

NASD                     National Association of Securities Dealers, Inc.

National Market          National Market System operated by Nasdaq

NOW account              Negotiable order of withdrawal account

NPV                      Net portfolio value

Offering                 Subscription, Community and Syndicated Community
                         Offerings, collectively

Option Plan              Stock option plan of the Company to be adopted no
                         earlier than six months after the Conversion

Order Form               Form for ordering stock accompanied by a certification
                         concerning certain matters

Other Members            Savings account holders (other than Eligible Account
                         Holders and Supplemental Eligible Account Holders) and
                         borrowers whose loans were outstanding on the Voting
                         Record Date who are entitled to vote at the Special
                         Meeting due to the existence of a savings account or a
                         borrowing, respectively, on the Voting Record Date for
                         the Special Meeting

Plan                     Plan of Conversion of 1st State Bank to effect the
                         Stock Conversion and the Bank Conversion

Purchase Price           $20.00 per share price of the common stock

SAIF                     Savings Association Insurance Fund of the FDIC

SEC                      Securities and Exchange Commission

Securities Act           Securities Act of 1933, as amended

SFAS                     Statement of Financial Accounting Standards adopted by
                         FASB

                                      A-2
<PAGE>
 
Special Meeting          Special Meeting of members of 1st State Bank called for
                         the purpose of approving the Plan of Conversion

Stock Conversion         Simultaneous conversion of 1st State Bank to a North
                         Carolina-chartered stock savings bank, the issuance of
                         the Converted Bank's outstanding capital stock to the
                         Company and the Company's offer and sale of its common
                         stock in the Offering

Subscription Offering    Offering of non-transferable rights to subscribe for
                         common stock, in order of priority, to Eligible Account
                         Holders, tax-qualified employee plans, Supplemental
                         Eligible Account Holders and Other Members

Supplemental Eligible    Depositors, who are not Eligible Account Holders of 1st
Account Holders          State Bank, with account balances of at least $50.00 on
                         December 31, 1998

Syndicated Community     Offering of shares of common stock remaining unsold
Offering                 after the Subscription Offering and undertaken prior to
                         the end and as part of the Community Offering, and
                         which may, at our discretion, be made to the general
                         public on a best efforts basis by a selling group of
                         broker-dealers

Trident Securities       Trident Securities, Inc.

Voting Record Date       The close of business on ___________, 1999, the date
                         for determining members of 1st State Bank entitled to
                         vote at the Special Meeting

                                      A-3
<PAGE>
 
  No dealer, salesman or other person has been authorized to give any
  information or to make any representations not contained in this document in
  connection with the offering made hereby, and, if given or made, such
  information or representations must not be relied upon as having been
  authorized by 1st State Bank, the Company, or Trident Securities.  This
  document does not constitute an offer to sell, or the solicitation of an offer
  to buy, any of the securities offered hereby to any person in any jurisdiction
  in which such offer or solicitation would be unlawful.  Neither the delivery
  of this document by 1st State Bank, the Company, or Trident Securities nor any
  sale made hereunder shall in any circumstances create an implication that
  there has been no change in the affairs of 1st State Bank or the Company,
  since any of the dates as of which information is furnished herein or since
  the date hereof.


                            1ST STATE BANCORP, INC.

                     (Holding Company for 1st State Bank)

                            UP TO 2,133,750 SHARES
                                 COMMON STOCK


                                  PROSPECTUS


                           TRIDENT SECURITIES,  INC.

                            DATED __________, 1999



                 THESE SECURITIES ARE NOT DEPOSITS OR ACCOUNTS
                  AND ARE NOT FEDERALLY INSURED OR GUARANTEED.

                     DEALER PROSPECTUS DELIVERY OBLIGATION

  UNTIL ________ __, 1999 (90 DAYS AFTER THE DATE OF THIS PROSPECTUS), ALL
  DEALERS THAT EFFECT TRANSACTIONS IN THESE SECURITIES, WHETHER OR NOT
  PARTICIPATING IN THIS OFFERING, MAY BE REQUIRED TO DELIVER A PROSPECTUS.  THIS
  IS IN ADDITION TO THE DEALERS OBLIGATION TO DELIVER A PROSPECTUS WHEN ACTING
  AS UNDERWRITERS AND WITH RESPECT TO THEIR UNSOLD ALLOTMENTS OR SUBSCRIPTIONS.
<PAGE>
 
                PART II: INFORMATION NOT REQUIRED IN PROSPECTUS

ITEM 13.  OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION

<TABLE>
<CAPTION>
<S>                                                        <C>
          Legal Fees and Expenses........................  $  160,000
          Printing, Postage and Mailing..................     150,000
          Appraisal and Business Plan Fees and Expenses..      35,000
          Conversion Agent Fees and Expenses.............      25,000
          Transfer Agent Fees and Stock Certificates.....      15,000
          Accounting Fees and Expenses...................     125,000
          Blue Sky Filing Fees and Expenses
            (including counsel fees).....................      15,000
          Filing Fees (Administrator, Commissioner,
             SEC, and NASD)..............................      50,000
       *  Underwriter's Fees and Expenses................     372,900
          Local Counsel..................................       5,000
          Other Expenses.................................      87,100
                                                           ----------
          Total..........................................  $1,040,000  **
                                                           ==========
</TABLE>

-------------------------
*  Calculation of Trident Securities' commissions assumes that the midpoint of
   the Estimated Valuation Range is sold in the Stock Conversion, 8% of the
   stock is purchased by the ESOP and all of the shares are purchased in the
   Subscription Offering.

** Assumes sale of 1,500,000 shares (the midpoint of the Estimated Valuation
   Range).


ITEM 14.  INDEMNIFICATION OF DIRECTORS AND OFFICERS

INDEMNIFICATION OF DIRECTORS AND OFFICERS OF THE COMPANY

     The Amended and Restated Certificate of Incorporation of 1st State Bank
provides that, to the fullest extent permitted by the North Carolina Business
Corporation Act (the "NCBCA"), no person who serves as a director shall be
personally liable to the Savings Bank or any of its stockholders or otherwise
for monetary damages for breach of any duty as director.

     In addition, Article IX of the Amended and Restated Bylaws of the Converted
Bank state that any individual who at any time serves or has served as a
director, officer, employee or agent of the Converted Bank, and any individual
who serves or has served at the request of the Converted Bank as a director,
officer, partner, trustee, employee or agent of another corporation,
partnership, joint venture, trust or other enterprise, or as a trustee or
administrator under an employee benefit plan, shall have a right to be
indemnified by the Converted Bank to the fullest extent permitted by law against
liability and litigation expense arising out of such status or activities in
such capacity.  Article IX of the Amended and Restated Bylaws of the Commercial
Bank contain similar provisions.

     Sections 55-8-50 through 55-8-58 of the NCBCA contain provisions
prescribing the extent to which directors and officers of the Converted Bank and
the Commercial Bank shall or may be indemnified. Section 55-8-51 of the NCBCA
permits a corporation, with certain exceptions, to indemnify a present or former
director against liability if (i) the director conducted himself in good faith,
(ii) the director reasonably believed (x) that the director's conduct in the
director's official capacity with the corporation was in its best interests and
(y) in all other cases the director's conduct was at least not opposed to the
corporation's best interests, and (iii) in the case of any criminal proceeding,
the director had no reasonable cause to believe the director's conduct was
unlawful. A corporation may not indemnify a director in connection with a
proceeding by or in the right of the corporation in which the director was
adjudged liable to the corporation or in connection with a proceeding charging
improper personal benefit to the director. The above standard of conduct is
determined by a majority vote of a quorum of the board of directors consisting
of directors not at the time

                                      II-1
<PAGE>
 
parties to the proceeding, or majority vote of a duly designated committee of
the board of directors, special legal counsel, or the shareholders as prescribed
in Section 55-8-55.

     Sections 55-8-52 and 55-8-56 of the NCBCA require a corporation to
indemnify a director or officer in the defense of any proceeding to which the
director or officer was a party against reasonable expenses when the director or
officer is wholly successful in the director's or officer's defense, unless the
articles of incorporation provide otherwise.  Upon application, the court may
order indemnification of the director or officer if the director or officer is
adjudged fairly and reasonably so entitled under Section 55-8-54.

     In addition, Section 55-8-57 of the NCBCA permits a corporation to provide
for indemnification of directors, officers, employees or agents, in its articles
of incorporation or bylaws or by contract or resolution, against liability in
various proceedings and to purchase and maintain insurance policies on behalf of
these individuals.  The Savings Bank currently maintains a directors and
officers liability insurance policy.

     Directors, officers and employees of the Company may be entitled to benefit
from the indemnification provisions contained in the Virginia Stock Corporation
Act (the "VSCA") and the Holding Company's Articles of Incorporation.  The
general effect of these provisions is summarized below.

     In accordance with Sections 13.1-696 through 13.1-704 of the VSCA, a
director or officer of the Company generally shall be indemnified in the defense
of a proceeding if they are successful.  A corporation may indemnify a director,
officer, employee or agent under the circumstances in the preceding sentence and
in other circumstances if (i) he conducted himself in good faith; and (ii) he
believed  (x) that his conduct in his official capacity with the corporation was
in its best interests and (y) in all other cases his conduct was at least not
opposed to the corporation's best interests, and (iii) in the case of any
criminal proceeding, he had no reasonable cause to believe that his conduct was
unlawful.  A corporation may not indemnify a director, officer, employee or
agent in connection with a proceeding by or in the right of the corporation in
which the individual was adjudged liable to the corporation or in connection
with a proceeding charging improper personal benefit to the individual.  The
above standard of conduct is determined by a majority vote of a quorum of the
board of directors consisting of directors not at the time parties to the
proceeding, or majority vote of a duly designated committee of the board of
directors, special legal counsel, or the shareholders as prescribed in Section
13.1-701.

     Sections 13.1-698 and  13.1-702 of the VSCA require a corporation to
indemnify a director or officer in the defense of any proceeding to which the
director or officer was a party against reasonable expenses when the director or
officer is wholly successful in the director's or officer's defense, unless the
articles of incorporation provide otherwise.  Upon application, the court may
order indemnification of the director or officer if the director or officer is
adjudged fairly and reasonably so entitled under Section 13.1-700.1.

     In addition, Section  13.1-704 of the VSCA permits a corporation to provide
for indemnification of directors, officers, employees or agents, in its articles
of incorporation or bylaws or by contract or resolution, against liability in
various proceedings and to purchase and maintain insurance policies on behalf of
these individuals, except an indemnity against willful misconduct or a knowing
violation of criminal law.

     Article XVI of the Holding Company's Articles of Incorporation provides
that the Holding Company shall indemnify, to the fullest extent permissible
under the VSCA, any individual who is or was a director, officer, employee or
agent of the Holding Company, and any individual who serves or served at the
Holding Company's request as a director, officer, partner, trustee, employee or
agent of another corporation, partnership, joint venture, trust, other
enterprise or employee benefit plan, in any proceeding in which the individual
is made a party as a result of his service in such capacity.  In addition, the
Holding Company must pay reasonable expenses incurred by any person identified
in the preceding sentence who is a party to a proceeding in advance of the final
disposition of the proceeding upon receipt by the Holding Company of:  (i) a
written affirmation by such person of his good faith belief that the standard of
conduct necessary for indemnification by the Holding Company as authorized in
Article XVI has been met; and (ii) 

                                      II-2
<PAGE>
 
a written undertaking by or on behalf of such person to repay the amount if it
shall ultimately be determined that the standard of conduct has not been met.

     Article XVI further provides that the Holding Company shall purchase and
maintain insurance on behalf of any person who holds or who has held any
position as a director or officer of the Holding Company against any liability
incurred by him or her in any such position, or arising out of his status as
such, whether or not the Corporation would have power to indemnify him or her
against such liability under Article XVI.

     The engagement letter dated July 24, 1998, between the Savings Bank and
Ferguson provides for the indemnification of Ferguson and its employees under
certain circumstances, in connection with the appraisal services rendered under
the terms of that engagement letter.  The engagement letter dated July 27, 1998,
between the Savings Bank and Trident Securities provides for the indemnification
of Trident Securities and its controlling persons under certain circumstances,
in connection with the Conversion and Trident Securities' engagement under the
engagement letter.  The Sales Agency Agreement to be entered into between
Trident Securities and the Company will provide for the indemnification of
Trident Securities, its affiliates, and their respective officers, directors,
employees, agents and controlling persons under certain circumstances.


ITEM 15. RECENT SALES OF UNREGISTERED SECURITIES.

      Not applicable.

ITEM 16. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES:

     The exhibits and financial statement schedules filed as a part of this
registration statement are as follows:

     (a)  LIST OF EXHIBITS
 
     1.1     Engagement Letter with Trident Securities, Inc.
 
  *  1.2     Sales Agency Agreement with Trident Securities, Inc.
 
     2       Plan of Conversion (Exhibit A to Proxy Statement filed as Exhibit
             99.2)

     3.1     Articles of Incorporation of 1st State Bancorp, Inc.
 
     3.2     Bylaws of 1st State Bancorp, Inc.
 
     4       Form of Common Stock Certificate of 1st State Bancorp, Inc.
 
     5       Opinion of Housley Kantarian & Bronstein, P.C. regarding legality
             of securities being registered
             
     8.1     Form of Federal Tax Opinion
 
     8.2     Form of State Tax Opinion
 
     8.3     Opinion of Ferguson & Company as to the value of subscription
             rights for tax purposes

     10.1    Proposed 1st State Bancorp, Inc. 1999 Stock Option and Incentive
             Plan
 

                                      II-3
<PAGE>
 
     10.2    Proposed 1st State Bancorp, Inc. Management Recognition Plan
 
     10.3    Employment Agreements by and between 1st State Bank and James C.
             McGill, A. Christine Baker and Fairfax C. Reynolds
 
     10.4    Form of Guaranty Agreement by and between 1st State Bancorp, Inc.
             and James C. McGill, A. Christine Baker and Fairfax C. Reynolds
             
     10.5    1st State Bank Deferred Compensation Plan
 
     23.1    Consent of Housley Kantarian & Bronstein, P.C. (filed herewith and 
             contained in opinion filed as Exhibit 5)
               
     23.2    Consent of KPMG Peat Marwick LLP
 
     23.3    Consent of Ferguson & Company
 
     24      Power of Attorney (reference is made to the signature page of the
             Form S-1)

     27      Financial Data Schedule

     99.1    Form of Proposed Stock Order Form and Form of Certification
 
     99.2    Proxy Statement for Special Meeting of Members of 1st State Bank;
             Form of Proxy
             
     99.3    Miscellaneous Solicitation and Marketing Materials
 
*    99.4    Appraisal Report

____________
* To be filed by amendment.

     (b)  FINANCIAL STATEMENT SCHEDULES.

     No financial statement schedules are filed because the required information
is not applicable or is included in the consolidated financial statements or
related notes.


ITEM 17. UNDERTAKINGS

     The undersigned registrant hereby undertakes:

     (1) To file, during any period in which offers or sales are being made, a
post-effective amendment to this registration statement:

         (i)  To include any prospectus required by Section 10(a)(3) of the
     Securities Act of 1933;

         (ii) To reflect in the prospectus any facts or events arising after
     the effective date of the registration statement (or the most recent post-
     effective amendment thereof) which, individually or in the aggregate,
     

                                      II-4
<PAGE>
 
     represent a fundamental change in the information set forth in the
     registration statement. Notwithstanding the foregoing, any increase or
     decrease in volume of securities offered (if the total dollar value of
     securities offered would not exceed that which was registered) and any
     deviation from the low or high end of the estimated maximum offering range
     may be reflected in the form of prospectus filed with the Commission
     pursuant to Rule 424(b) if, in the aggregate, the changes in volume and
     price represent no more than 20 percent change in the maximum aggregate
     offering price set forth in the "Calculation of Registration Fee" table in
     the effective registration statement;

          (iii)  To include any material information with respect to the plan of
     distribution not previously disclosed in the registration statement or any
     material change to such information in the registration statement.

     (2)  That, for the purpose of determining any liability under the
Securities Act of 1933, each such post-effective amendment shall be deemed to be
a new registration statement relating to the securities offered therein, and the
offering of such securities at that time shall be deemed to be the initial bona
fide offering thereof.

     (3)  To remove from registration by means of a post-effective amendment any
of the securities being registered which remain unsold at the termination of the
offering.

     The undersigned registrant hereby undertakes to provide to the underwriter
at the closing specified in the underwriting agreements, certificates in such
denominations and registered in such names as required by the underwriter to
permit prompt delivery to each purchaser.

     Insofar as indemnification for liabilities arising under the Securities Act
of 1933 may be permitted to directors, officers and controlling persons of the
registrant pursuant to the foregoing provisions, or otherwise, the registrant
has been advised that in the opinion of the Securities and Exchange Commission
such indemnification is against public policy as expressed in the Act, and is
therefore, unenforceable.  In the event that a claim for indemnification against
such liabilities (other than the payment by the registrant of expenses incurred
or paid by a director, officer or controlling person of the registrant in the
successful defense of any action, suit or proceeding) is asserted by such
director, officer or controlling person in connection with the securities being
registered, the registrant will, unless in the opinion of its counsel the matter
has been settled by controlling precedent, submit to a court of appropriate
jurisdiction the questions whether such indemnification by it is against public
policy as expressed in the Act and will be governed by the final adjudication of
such issue.

                                      II-5
<PAGE>
 
                                  SIGNATURES

     Pursuant to the requirements of the Securities Act of 1933, as amended, the
registrant has duly caused this registration statement to be signed on its
behalf by the undersigned, thereunto duly authorized, in the City of Burlington,
State of North Carolina, on November 25, 1998.

                              1ST STATE BANCORP, INC.



                              By: /s/ James C. McGill
                                  -------------------------------
                                  James C. McGill
                                  President

                               POWER OF ATTORNEY

     We, the undersigned Directors of 1st State Bancorp, Inc., hereby severally
constitute and appoint James C. McGill, with full power of substitution, our
true and lawful attorney and agent, to do any and all things in our names in the
capacities indicated below which said James C. McGill may deem necessary or
advisable to enable 1st State Bancorp, Inc. to comply with the Securities Act of
1933, as amended, and any rules, regulations and requirements of the Securities
and Exchange Commission, in connection with the registration of 1st State
Bancorp, Inc. common stock, including specifically, but not limited to, power
and authority to sign for us in our names in the capacities indicated below, the
registration statement and any and all amendments (including post-effective
amendments) thereto; and we hereby ratify and confirm all that said James C.
McGill shall do or cause to be done by virtue thereof.

     Pursuant to the requirements of the Securities Act of 1933, as amended,
this registration statement has been signed below by the following persons in
the capacities and on the dates indicated.


<TABLE> 
<CAPTION> 
   Signatures                    Title                                               Date
   ----------                    -----                                               ----
<S>                            <C>                                              <C> 
/s/ James C. McGill            President, Chief Executive Officer               November 25, 1998
----------------------------
James C. McGill                and Director (Principal Executive Officer)
 
/s/ A. Christine Baker         Executive Vice President-Chief                   November 25, 1998
----------------------------
A. Christine Baker             Financial Officer, Secretary and
                               Treasurer (Principal Financial and
                               Accounting Officer)
 
/s/ Richard C. Keziah          Chairman of the Board                            November 25, 1998
----------------------------
Richard C. Keziah
 
/s/ James A. Barnwell, Jr.     Director                                         November 25, 1998
----------------------------
James A. Barnwell, Jr.
 
/s/ Bernie C. Bean             Director                                         November 25, 1998
----------------------------
Bernie C. Bean
 
/s/ James G. McClure           Director                                         November 25, 1998
----------------------------
James G. McClure
 
/s/ T. Scott Quakenbush        Director                                         November 25, 1998
----------------------------
T. Scott Quakenbush
 
/s/ Richard H. Shirley         Director                                         November 25, 1998
----------------------------
Richard H. Shirley
 
/s/ Virgil L. Stadler          Director                                         November 25, 1998
----------------------------
Virgil L. Stadler
</TABLE>
[{"type": "S-1", "sequence": "1", "description": "FORM S-1", "secsgml_size_bytes": 631582}]
{"company-data": {"conformed-name": "1ST STATE BANCORP INC", "cik": "0001074078", "assigned-sic": ""}, "filing-values": {"form-type": "S-1", "act": "33", "file-number": "333-68091", "film-number": "98761413"}, "business-address": {"street1": "445 S MAIN ST", "city": "BURLINGTON", "state": "NC", "zip": "27215", "phone": "3362278861"}, "mail-address": {"street1": "445 S MAIN ST", "street2": "C/O 1ST STATE BANCORP INC", "city": "BURLINGTON", "state": "NC", "zip": "27215"}}
As filed with the Securities and Exchange Commission on November 30, 1998
                                                    Registration No. 333-_______
================================================================================
                       SECURITIES AND EXCHANGE COMMISSION
                            WASHINGTON, D.C.  20549
                          ---------------------------
                                    FORM S-1
                             REGISTRATION STATEMENT
                                     UNDER
                           THE SECURITIES ACT OF 1933
                         -----------------------------

                            1ST STATE BANCORP, INC.
            (Exact name of registrant as specified in its charter)
VIRGINIA                          6035                    [APPLIED FOR]
  (State or other jurisdiction      (Primary standard industrial     (I.R.S. employer
of incorporation or organization)    classification code number)   identification number)
445 S. MAIN STREET
                       BURLINGTON, NORTH CAROLINA  27215
                                (336) 227-8861
         (Address, including zip code, and telephone number, including
            area code, of registrant's principal executive offices)

                                JAMES C. MCGILL
                     PRESIDENT AND CHIEF EXECUTIVE OFFICER
                            1ST STATE BANCORP, INC.
                              445 S. MAIN STREET
                       BURLINGTON, NORTH CAROLINA  27215
                                (336) 227-8861
           (Name, address, including zip code, and telephone number,
                  including area code, of agent for service)

                                  COPIES TO:
                          Gary R. Bronstein, Esquire
                          Joel E. Rappoport, Esquire
                      Housley Kantarian & Bronstein, P.C.
                       1220 19th Street, N.W., Suite 700
                            Washington, D.C.  20036

     APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC: As soon as
practicable after this registration statement becomes effective.

If any of the securities being registered on this form are to be offered on a
delayed or continuous basis pursuant to Rule 415 of the Securities Act of 1933,
check the following box: [_]

If this form is filed to register additional securities for an offering pursuant
to Rule 462(b) under the Securities Act, please check the following box and list
the Securities Act registration statement number of the earlier effective
registration statement for the same offering. [_]

If this form is a post-effective amendment filed pursuant to Rule 462(c) under
the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [_]

If delivery of the prospectus is expected to be made pursuant to Rule 434,
please check the following box. [_]

                        CALCULATION OF REGISTRATION FEE
============================================================================================= 
   TITLE OF EACH CLASS       AMOUNT    PROPOSED MAXIMUM   PROPOSED MAXIMUM     AMOUNT OF
      OF SECURITIES          TO BE      OFFERING PRICE   AGGREGATE OFFERING   REGISTRATION
    TO BE REGISTERED       REGISTERED    PER SECURITY    OFFERING PRICE (1)       FEE
---------------------------------------------------------------------------------------------
Common Stock, par value
  $.01 per share.........   2,133,750     $  20.00       $   42,675,000       $  11,863.65
=============================================================================================
(1)  Estimated solely for purposes of calculating the registration fee.

     THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR
DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL
FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION
STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(A) OF
THE SECURITIES ACT OF 1933 OR UNTIL THE REGISTRATION STATEMENT SHALL BECOME
EFFECTIVE ON SUCH DATE AS THE SECURITIES AND EXCHANGE COMMISSION, ACTING
PURSUANT TO SAID SECTION 8(A), MAY DETERMINE.
PROSPECTUS
UP TO 2,133,750 SHARES OF COMMON STOCK
$20.00 PER SHARE
                                         1st STATE BANCORP, INC.
                                              445 S. MAIN STREET
                                              BURLINGTON, NORTH CAROLINA  27215
                                              (336) 227-8861
================================================================================
1st State Bank is converting from the mutual form to the stock form of
organization.  As part of the transaction,  1st State Bank will become a wholly
owned subsidiary of 1st State Bancorp, Inc., a corporation we recently formed
for the purpose of serving as our holding company.  As part of this process, we
are offering shares of 1st State Bancorp, Inc. common stock to the public.
Immediately following the completion of the Stock Conversion, we will convert to
a North Carolina commercial bank.
================================================================================
                             TERMS OF THE OFFERING

Ferguson & Company, an independent appraiser, has estimated the market value of
the converted 1st State Bank to be between $25,500,000 and $34,500,000, which
establishes the amount of stock to be sold.  Subject to regulatory approval, we
may increase the maximum amount offered by up to 15%.  Accordingly, at the
purchase price of $20.00 per share, we are offering a minimum of 1,275,000
shares and a maximum, as adjusted, of 1,983,750 shares.  Based on these
estimates, we are making the following offering of shares of common stock:
Per Share                   Total
                                                                 ---------                   -----
.    Purchase Price:  Minimum to Maximum, as adjusted       $20.00              $25,500,000 to $39,675,000
 
     .    Offering Expenses, Including Underwriting Discounts
          and Commissions: Minimum to  Maximum, as adjusted       $.77 to $.59        $978,000 to $1,173,000
 
     .    Net Proceeds to the Company:  Minimum to Maximum,       $19.23 to $19.41    $24,522,000 to $38,502,000
          as adjusted
PLEASE REFER TO RISK FACTORS BEGINNING ON PAGE 1 OF THIS DOCUMENT.

These securities are not deposits or accounts and are not insured or guaranteed
by the FDIC or any other government agency.

Neither the Securities and Exchange Commission, the Administrator, the FDIC, nor
any state securities commission has approved or disapproved of these securities
or determined if this prospectus is truthful or complete.  Any representation to
the contrary is a criminal offense.

The common stock will be traded under the symbol "_____" on the Nasdaq National
Market.

The underwriters, Trident Securities, Inc., must sell the minimum number of
securities (1,275,000 shares of common stock) if any are sold.  The underwriters
are required to use only their best efforts to sell the maximum number of
securities offered (1,725,000 shares of common stock).

The Subscription Offering expires at 12:00 Noon Eastern Time, on __________,
1999, unless we extend it for up to 90 days.  We may terminate the Community
Offering at any time without notice.  Pending completion or termination of the
Offering, we will place funds for stock purchases in a segregated savings
account at 1st State Bank and we will pay interest at our passbook rate on funds
received for the period the funds are held until the completion or termination
of the Offering.

FOR INFORMATION ON HOW TO SUBSCRIBE, CALL THE STOCK INFORMATION CENTER AT (336)
___-____.

                            TRIDENT SECURITIES, INC.

                              ______________, 1999
[INSIDE FRONT COVER OF PROSPECTUS]

                               TABLE OF CONTENTS
Page
                                                                                          ----
Questions and Answers About the Conversion and the Offering ...........................    (i)
Summary................................................................................   (iv)
Selected Consolidated Financial Information and Other Data.............................  (vii)
Risk Factors...........................................................................     1
Proposed Management Purchases..........................................................     6
Use of Proceeds........................................................................     7
Dividend Policy........................................................................     7
Market for the Common Stock............................................................     8
Capitalization.........................................................................     9
Historical and Pro Forma Regulatory Capital Compliance.................................    11
Pro Forma Data.........................................................................    13
Comparison of Valuation and Pro Forma Information with No Foundation...................    16
The Conversion.........................................................................    17
Management's Discussion and Analysis of Financial Condition and Results of Operations..    34
Business of 1st State Bancorp, Inc.....................................................    48
Business of 1st State Bank.............................................................    49
Regulation.............................................................................    73
Taxation...............................................................................    82
Management of the Company..............................................................    83
Management of the Bank.................................................................    84
Certain Restrictions on Acquisition of the Company and the Converted Bank..............    92
Certain Anti-Takeover Provisions in the Articles of Incorporation and Bylaws...........    94
Description of Capital Stock...........................................................    99
Registration Requirements..............................................................   101
Legal Matters..........................................................................   101
Tax Opinions...........................................................................   101
Experts................................................................................   101
Additional Information.................................................................   101
Index to Consolidated Financial Statements.............................................   103
Please see the Glossary beginning on page A-1 for the meaning of
                              capitalized terms.
QUESTIONS AND ANSWERS ABOUT THE CONVERSION
                               AND THE OFFERING

Q:   WHAT IS THE STOCK CONVERSION?

A:   The Stock Conversion is a change in our form of organization from mutual to
     stock form. Currently, we operate as a North Carolina-chartered mutual
     savings bank with no stockholders. As a result of the Stock Conversion, we
     will become a North Carolina-chartered stock savings bank. As part of our
     Stock Conversion, you may have the opportunity to become a stockholder of
     our newly formed holding company, 1st State Bancorp, Inc.

Q:   WHAT IS THE BANK CONVERSION?

A:   The Bank Conversion is the conversion of our charter from that of a North
     Carolina-chartered stock savings bank to that of a North Carolina-chartered
     commercial bank. The Bank Conversion will occur immediately following the
     completion of the Stock Conversion. We refer to the Stock Conversion and
     the Bank Conversion collectively as the "Conversion."

Q:   WHAT IS THE PURPOSE OF THE STOCK CONVERSION AND THE OFFERING?

A:   With the holding company structure, we will have the ability to plan and
     develop long-term growth opportunities and to access the capital markets
     more easily in the future. The Offering will increase our capital and the
     amount of funds available to us for lending and investment. This will give
     us greater flexibility to diversify operations and expand into other
     geographic markets, if we choose to do so. If our earnings are sufficient
     in the future, you might also receive dividends and benefit from the long-
     term appreciation of our stock price.

Q:   WHAT IS THE PURPOSE OF THE BANK CONVERSION?

A:   Conversion to a commercial bank charter will enable us to continue to
     pursue our expanding lines of business by increasing our investment in
     commercial real estate loans, commercial loans and consumer loans.

Q:   HOW DO I SUBSCRIBE FOR THE STOCK?

A:   You must complete and return the stock order form and certification form to
     us together with your payment or your authorization for withdrawal of the
     payment amount from an account you have with us, on or before 12:00 Noon on
     __________, 1999.

Q:   HOW MUCH STOCK MAY I PURCHASE?

A:   The minimum purchase is 25 shares (or $500). The maximum purchase per
     eligible depositor (which includes individuals on joint accounts or having
     the same address on our records) in the Subscription Offering is 50,000
     shares ($1,000,000). We may decrease or increase the maximum purchase
     limitation without notifying you.

     If shares are sold in a Community Offering (or a Syndicated Community
     Offering), the maximum number of shares that may be purchased by any party
     (which includes individuals on joint accounts or having the same address on
     our records) in the Community Offering (or a Syndicated Community
     Offering), when combined with the number of shares purchased by other
     parties with whom your shares may be aggregated is 50,000 shares
     ($1,000,000).

     Total purchases of stock in the Offering (i.e., combined purchases in the
     Subscription, Community and Syndicated Community Offerings) may not
     exceed $1,000,000.

                                      (i)
Q:   WHAT HAPPENS IF THERE ARE NOT ENOUGH SHARES TO FILL ALL ORDERS?

A:   You might not receive any or all of the shares for which you subscribe. If
     orders are received for more shares than are available, the stock will be
     offered to the following persons or groups in order of priority.

     .  ELIGIBLE ACCOUNT HOLDERS - Depositors who had a deposit account with us
        on December 31, 1994 with a balance of at least $50.00. Any remaining
        shares will be offered to:

     .  OUR ESOP.  Any remaining shares will be offered to:

     .  SUPPLEMENTAL ELIGIBLE ACCOUNT HOLDERS - Depositors who had a deposit
        account with us on December 31, 1998 with a balance of at least $50.00.
        Any remaining shares will be offered to:

     .  OTHER MEMBERS - Other depositors and certain borrowers of ours, as of
        __________, 1999.

     If the above persons do not subscribe for all of the shares, the remaining
     shares will be offered to certain members of the general public with
     preference given to people who live in Alamance County, North Carolina.

Q.   WILL THE COMMON STOCK BE LISTED ON A STOCK EXCHANGE?

A.   Yes. We have received conditional approval for the common stock to be
     traded under the symbol "_____" on the Nasdaq National Market.

Q:   IS THE COMPANY'S COMMON STOCK INSURED BY THE FDIC?

A:   No. The Company's common stock is not a deposit or an account and is not
     insured or guaranteed by the FDIC or any other government agency.

Q:   WHAT PARTICULAR FACTORS SHOULD I CONSIDER WHEN DECIDING WHETHER OR NOT TO
     BUY THE STOCK?

A:   There are numerous risks associated with purchasing our stock. Before you
     decide to purchase stock, you should read this entire document, including
     the Risk Factors section beginning on page 1 of this document.

Q:   WILL THE CONVERSION AFFECT ANY DEPOSIT OR LOAN ACCOUNTS OR MY VOTING
     RIGHTS IN 1ST STATE BANK?

A:   Your deposit account, certificate accounts and any loans you may have with
     us will be not be affected by the Conversion or the Offering. Deposits will
     continue to be insured by the FDIC up to applicable limits. You presently
     have voting rights while we are in the mutual form; however, once we
     convert to the stock form all voting rights will belong to stockholders.
     You are not required to purchase stock.

Q:   WHO CAN ANSWER ANY OTHER QUESTIONS I MAY HAVE ABOUT THE CONVERSION AND
     THE OFFERING?

A:   In order to make an informed investment decision, you should read this
     entire document.  In addition, you may contact:

                           STOCK INFORMATION CENTER
                            1ST STATE BANCORP, INC.
                              445 S. MAIN STREET
                       BURLINGTON, NORTH CAROLINA  27215
                                (336) ___-____

                                     (ii)
[MAP OF BANK'S MARKET AREA APPEARS HERE]

                                     (iii)
SUMMARY

       This summary highlights selected information from this document and may
not contain all the information that is important to you. To understand the
stock offering fully, you should read this entire document carefully, including
the consolidated financial statements and the notes to the consolidated
financial statements of 1st State Bank. References in this document to the
"Bank," "we," "us," and "our" refer to 1st State Bank. Where appropriate, "us"
or "our" refers collectively to 1st State Bancorp, Inc. and 1st State Bank.
References in this document to "the Company" refer to 1st State Bancorp, Inc.

1ST STATE BANCORP, INC.

       1st State Bancorp, Inc, was formed in November 1998 as a Virginia
corporation to be the holding company for 1st State Bank following the
Conversion. The Company is not an operating company and has not engaged in any
significant business to date. The holding company structure will provide greater
flexibility in terms of operations, expansion and diversification. See "The
Conversion -- Business Purposes."

       The Company's executive offices are located at 445 S. Main Street,
Burlington, North Carolina 27215, and its main telephone number is (336) 227-
8861.

1ST STATE BANK

       Founded in 1914, we are a community and customer oriented North Carolina-
chartered savings bank headquartered in Burlington, North Carolina. We have five
full service branch offices located in north central North Carolina on the
Interstate 85 corridor between the Piedmont Triad and Research Triangle. Our
primary market area consists of Alamance County, North Carolina.

       Our business consists principally of attracting deposits from the general
public and investing these funds in loans secured by single-family residential
and commercial real estate, secured and unsecured commercial loans and consumer
loans. Our profitability depends primarily on our net interest income, which is
the difference between the income we receive on our loan and investment
securities portfolios and our cost of funds, which consists of interest paid on
deposits and borrowed funds. We also earn income from miscellaneous fees related
to our loans and deposits, mortgage banking income and commissions from sales of
annuities and mutual funds. At September 30, 1998, we had total assets of $288.2
million, deposits of $235.7 million and total net worth of $26.0 million.

       Our executive offices are located at 445 S. Main Street, Burlington,
North Carolina 27215, and our main telephone number is (336) 227-8861.

       After completion of the Bank Conversion, we will be a North Carolina-
chartered commercial bank, and we will retain our current name "1st State Bank."
As a commercial bank, we intend to continue to follow our same business
strategies and will be subject to the regulation and supervision of the FDIC and
the Commission. See "The Conversion --Business Purposes."

THE CONVERSION

       The Conversion consists of the Stock Conversion followed immediately by
the Bank Conversion. Pursuant to the Stock Conversion, we will convert from
mutual to stock form and will become a wholly owned subsidiary of the Company.
Pursuant to the Bank Conversion, we will convert to a North Carolina-chartered
commercial bank and will remain a wholly owned subsidiary of the Company.

                                     (iv)
THE OFFERING

       As part of the Stock Conversion, the Company is offering between
1,275,000 and 1,725,000 shares of common stock at $20.00 per share. Subject to
regulatory approval, the number of shares to be sold may be increased to
1,983,750 shares without any further notice to you if market or financial
conditions change prior to the completion of the Stock Conversion.

       The Company is first offering its shares of common stock in a
Subscription Offering. Depositor and borrower members as of certain eligibility
dates will receive subscription rights. The shares of common stock will be
offered on the basis of priorities. Any remaining shares may be offered in a
Community Offering or in a Syndicated Community Offering. See "The Conversion --
Subscription Rights."

CHARITABLE FOUNDATION

       In furtherance of our long-standing commitment to our local community, we
will establish a charitable foundation which will be dedicated to charitable and
community service causes within our market area. In connection with the Stock
Conversion, we will contribute up to 150,000 shares of common stock to fund the
Foundation's operations. We expect to realize an after-tax expense of $2.0
million during the quarter ended March 31 or June 30, 1999 as a result of our
contribution to the Foundation. See "Risk Factors -- The Expense and Dilutive
Effect of the Contribution of Shares to the Charitable Foundation" and "The
Conversion -- Establishment of the Foundation."

SUBSCRIPTION RIGHTS ARE NOT TRANSFERABLE

       You may not assign or sell your subscription rights. Any transfer of
subscription rights is prohibited by law. If you exercise subscription rights,
you will be required to certify that you are purchasing shares solely for your
own account and that you have no agreement or understanding regarding the sale
or transfer of shares. We intend to pursue any and all legal and equitable
remedies in the event that we become aware of the transfer of any subscription
rights. We will reject orders that we determine to involve the transfer of
subscription rights.

THE OFFERING RANGE AND DETERMINATION OF THE PRICE PER SHARE

       The offering range is based on an independent appraisal of the pro forma
market value of the Converted Bank by Ferguson, an appraisal firm experienced in
appraisals of savings institutions. The pro forma market value is our estimated
market value after giving effect to the sale of shares in this Offering.
Ferguson has estimated that in its opinion as of October 30, 1998 the value
ranged between $25.5 million and $34.5 million (with a midpoint of $30.0
million). We refer to this range as the "Estimated Valuation Range." The
appraisal was based in part upon our financial condition and operations and the
effect of additional capital raised by the sale of common stock in this
Offering. The $20.00 price per share was determined by our Board of Directors.
Subject to regulatory approval, an amount of common stock up to 15% above the
maximum of the Estimated Valuation Range may be offered. We are offering a
minimum of 1,275,000 shares of common stock and a maximum, as adjusted of
1,983,750 shares of common stock. The appraisal will be updated prior to the
completion of the Stock Conversion. If the pro forma market value of the common
stock at that time is either below $25.5 million or above $39.7 million, we will
notify you and you will have the opportunity to modify or cancel your order. See
"The Conversion -- Stock Pricing and Number of Shares to be Issued."

                                      (v)
TERMINATION OF THE STOCK OFFERING

       The Subscription Offering will terminate at 12:00 Noon, Eastern Time, on
__________, ___________, 1999. The Community Offering and Syndicated Community
Offering, if any, may terminate at any time without notice but will terminate no
later than __________, 1999, without approval of the Administrator and the FDIC.

BENEFITS TO MANAGEMENT FROM THE OFFERING

       Our full-time employees will participate in the Offering through the
purchase of stock by our ESOP, which is a form of retirement plan. Following the
Conversion, we also intend to implement a restricted stock plan and a stock
option plan, which will benefit our officers and directors. These plans will not
be adopted until at least six months after the Stock Conversion. If we adopt a
restricted stock plan, our executive officers and directors will be awarded
shares of common stock at no cost to them. See "Management of the Bank --
Proposed Future Stock Benefit Plans."

USE OF PROCEEDS FROM THE SALE OF THE COMMON STOCK

       We will use the net proceeds from the Offering as follows. The
       percentages we use are estimates:

       .   50% will be invested in the Bank by buying all the capital stock of
           the Converted Bank

       .   8% will be loaned to our employee stock ownership plan to fund its
           purchase of common stock

       .   42% will be retained for other general corporate purposes, and may be
           used as a possible source of funds for the payment of dividends to
           stockholders or the repurchase of stock.

       The proceeds to be received by the Bank will be available for general
corporate purposes, including the continued expansion of our retail banking
franchise through continued growth in the loan portfolio, the opening of new
branches, deposit or bank acquisitions, and the purchase of investment
securities. See "Use of Proceeds."

DIVIDENDS

       We intend to pay an annual cash dividend of $.40 per share, payable
quarterly at $.10 per share. The payment of dividends is expected to commence
following the first full quarter after completion of the Offering. For a
discussion of our anticipated dividend policy, including restrictions on our
ability to pay dividends, see "Dividend Policy."

MARKET FOR THE COMMON STOCK

       We have received conditional approval to list the common stock on the
Nasdaq National Market under the symbol "_____".  See "Market for the Common
Stock."

RISKS IN OWNING THE COMMON STOCK

       Before you decide to purchase stock in the Offering, you should read this
entire document, including the Risk Factors section beginning on page 1 of
this document.

       The shares of common stock we are offering:

       .   Are not deposit accounts;

       .   Are not insured or guaranteed by the FDIC or any other government
           agency; and

       .   Are not guaranteed by us.

       The common stock is subject to investment risk, including the possible
  loss of principal invested.

                                     (vi)
SELECTED CONSOLIDATED FINANCIAL INFORMATION AND OTHER DATA

     The following summary consolidated financial information is derived from
our audited consolidated financial statements at the dates and for each of the
fiscal years shown below. The following information is only a summary and you
should read it in conjunction with our consolidated financial statements and the
notes to our consolidated financial statements, which you can find beginning on
page F-1 of this Prospectus.

SELECTED FINANCIAL CONDITION DATA
At September 30,
                                                         ------------------------------------------------
                                                           1998      1997      1996      1995      1994
                                                         --------  --------  --------  --------  --------
                                                                              (In thousands)
Total assets.........................................    $288,223  $258,509  $235,138  $222,916  $208,332         
Loans receivable.....................................     196,782   197,122   173,849   171,093   154,195         
Loans held for sale, at lower of cost or fair value..       7,540       684     2,377        --        --         
Cash and cash equivalents............................      31,077    14,990     9,754     7,550     4,858         
Investment securities:                                                                                            
  Available for sale.................................       9,858    11,320    16,024    16,307    19,004         
  Held to maturity...................................      30,195    23,482    21,685    17,649    18,197         
Deposit accounts.....................................     235,694   229,341   209,707   200,769   188,309         
Advances from Federal Home Loan Bank.................      20,000     1,000     1,000        --     1,000         
Net worth (1)........................................      25,966    23,277    20,629    19,151    16,530
__________
(1)       Consists of retained income, substantially restricted, and net
          unrealized gains or losses on securities available for sale.

SELECTED OPERATING DATA
Year Ended September 30,           
                                                         -----------------------------------------------
                                                           1998      1997      1996      1995     1994  
                                                         -------   -------   -------   -------   -------
                                                                    (In thousands)
Total interest income................................    $20,708   $19,061   $17,395   $16,146   $13,374   
Total interest expense...............................     11,071     9,799     9,453     8,584     7,175   
                                                         -------   -------   -------   -------   -------   
Net interest income..................................      9,637     9,262     7,942     7,562     6,199   
Provision for loan losses............................        477       261       281       454       240   
                                                         -------   -------   -------   -------   -------   
Net interest income after provision                                                                        
 for loan losses.....................................      9,160     9,001     7,661     7,108     5,959   
Other income.........................................      1,497     1,468     1,179     1,600       295   
Operating expenses...................................      6,774     6,473     6,403     5,006     4,316   
                                                         -------   -------   -------   -------   -------    
Income before income taxes...........................      3,883     3,996     2,437     3,702     1,938    
Income taxes.........................................      1,362     1,447       841     1,378       686    
                                                         -------   -------   -------   -------   -------    
Net income...........................................    $ 2,521   $ 2,549   $ 1,596   $ 2,324   $ 1,252    
                                                         =======   =======   =======   =======   =======
(vii)
SELECTED FINANCIAL RATIOS AND OTHER DATA
At or for the
                                                                   Year Ended September 30,
                                                        -------------------------------------------------
                                                          1998       1997      1996     1995      1994
                                                        -------    -------   -------  -------   --------
PERFORMANCE RATIOS:
 Return on average assets (net income divided
   by average total assets)...........................      0.92%      1.03%    0.70%    1.07%      0.60%       
 Return on average net worth (net income                                                                        
   divided by average net worth)......................     10.20      11.34     7.92    12.94       7.75        
 Interest rate spread (combined weighted average                                                                
   interest rate earned less combined weighted                                                                  
   average interest rate cost)........................      3.45       3.70     3.41     3.45       3.06        
 Net interest margin (net interest income divided by                                                            
   average interest-earning assets)...................      3.77       4.00     3.68     3.68       3.20        
 Ratio of average interest-earning assets                                                                       
   to average interest-bearing liabilities............    107.42     106.99   106.25   105.61     103.88        
 Ratio of operating expenses to average total assets..      2.48       2.62     2.80     2.30       2.07         
 
ASSET QUALITY RATIOS:
 Nonperforming assets to total assets
   at end of period...................................      0.09       0.10     0.12     1.64       1.58       
 Nonperforming loans to total loans                                                                            
   at end of period...................................      0.13       0.13     0.16     2.11       0.06       
 Allowance for loan losses to total                                                                            
   loans at end of period.............................      1.61       1.38     1.42     1.28       1.13       
 Allowance for loan losses to nonperforming                                                                    
   loans at end of period.............................  1,227.38   1,063.32   866.67    60.72   1,784.85       
 Provision for loan losses to total loans.............      0.24       0.13     0.16     0.26       0.15       
 Net charge-offs to average loans                                                                              
   outstanding........................................        --         --       --       --       0.01       
                                                                                                               
CAPITAL RATIOS:                                                                                                
 Net worth to total assets at                                                                                  
   end of period......................................      9.01       9.00     8.77     8.59       7.93       
 Average net worth to average assets..................      9.05       9.10     8.80     8.25       7.75
At September 30,
                                                        -----------------------------------------------
                                                           1998       1997     1996     1995     1994
                                                         -------    -------   ------   ------   -------
Number of:
  Loans outstanding...................................     6,253      6,410    6,404    6,675     6,848     
  Deposit accounts....................................    26,066     26,924   27,187   27,850    27,399     
  Offices open (1)....................................         6          6        6        5         5
___________
(1)  All offices are full service offices.

                                    (viii)
RISK FACTORS

       IN ADDITION TO THE OTHER INFORMATION IN THIS DOCUMENT, YOU SHOULD
  CONSIDER CAREFULLY THE FOLLOWING RISK FACTORS IN DECIDING WHETHER TO INVEST IN
  THE COMMON STOCK.  CERTAIN STATEMENTS IN THIS DOCUMENT ARE FORWARD-LOOKING AND
  ARE IDENTIFIED BY THE USE OF FORWARD-LOOKING WORDS OR PHRASES SUCH AS
  "INTENDED," "WILL BE POSITIONED," "EXPECTS," IS OR ARE "EXPECTED,"
  "ANTICIPATES," AND "ANTICIPATED" AND OTHER WORDS AND PHRASES OF SIMILAR
  MEANING.  THESE FORWARD-LOOKING STATEMENTS ARE BASED ON OUR CURRENT
  EXPECTATIONS.  TO THE EXTENT ANY OF THE INFORMATION CONTAINED IN THIS DOCUMENT
  CONSTITUTES A FORWARD-LOOKING STATEMENT, THE RISK FACTORS SET FORTH BELOW ARE
  CAUTIONARY STATEMENTS IDENTIFYING IMPORTANT FACTORS THAT COULD CAUSE ACTUAL
  RESULTS TO DIFFER MATERIALLY FROM THOSE IN THE FORWARD-LOOKING STATEMENT.

  RISKS RELATED TO COMMERCIAL AND CONSUMER LENDING

       We generally invest a greater proportion of our assets in loans secured
  by commercial real estate, commercial loans and consumer loans than typical
  savings institutions that invest a greater proportion of their assets in loans
  secured by single-family residences.  At September 30, 1998, commercial real
  estate, commercial loans and consumer loans totaled $38.8 million, $25.2
  million and $6.3 million, respectively, which represented 18.8%,12.2% and
  3.1%, respectively, of gross loans.  At September 30, 1998, $100.9 million, or
  48.8% of gross loans, consisted of residential real estate mortgage loans.
  Our business plan calls for continued efforts to increase the percentage of
  our assets invested in commercial real estate loans, commercial loans and
  consumer loans.

       Commercial real estate loans and commercial loans generally involve a
  higher degree of credit risk than residential mortgage lending due primarily
  to the large amounts loaned to individual borrowers.  At September 30, 1998,
  our ten largest lending relationships ranged in size from $2.4 million to $4.3
  million.  Losses incurred on loans to a small number of borrowers could have a
  material adverse impact on our income and financial condition.  In addition,
  unlike residential mortgage loans,  commercial and commercial real estate
  loans depend on the cash flow from the property or the business to service the
  debt.  Cash flow may be significantly affected by general economic conditions.
  Consumer lending is riskier than residential mortgage lending because consumer
  loans are either unsecured or secured by assets that depreciate in value.

  POTENTIALLY ADVERSE IMPACT OF INTEREST RATES

       Our ability to earn a profit, like that of most financial institutions,
  is substantially dependent on our net interest income, which is the difference
  between the interest income we earn on our interest-earning assets (such as
  mortgage loans and investments) and the interest expense we pay on our
  interest-bearing liabilities (such as deposits).  Our profitability depends on
  our ability to manage our assets and liabilities during periods of changing
  market interest rates.  A sustained decrease in market interest rates could
  adversely affect our earnings.

       Changes in interest rates also can affect the average life of loans and
  investment securities.  When interest rates decline, borrowers tend to
  refinance higher-rate, fixed-rate loans at lower rates.  Under those
  circumstances, we would not be able to reinvest those prepayments in assets
  earning interest rates as high as the rates on the prepaid loans or investment
  securities.  As a result our interest income could decline.

  ANTICIPATED LOW RETURN ON EQUITY FOLLOWING CONVERSION

       Return on average equity (net income divided by average equity) is a
  ratio used by many investors to compare the performance of a financial
  institution to its peers.  As a result of the Conversion, our equity will
  increase substantially.  Our expenses also will increase due to added expense
  associated with our employee stock ownership plan and, later on, our
  restricted stock plan, as well as with the costs of being a public company.
  Because of the increases in our equity and expenses, until we are able to
  increase our balance sheet by adding loans and deposits, thereby 

                                       1
increasing net interest income, we expect our return on equity to decrease as
  compared to our performance in previous years.

  UNCERTAINTY AS TO EXISTENCE OF GROWTH OPPORTUNITIES

       To fully use capital raised in the Offering, if sufficient growth
  opportunities are not available in our market area, we may seek to expand into
  suitable market areas by either establishing one or more new branches or by
  acquiring another financial institution or branches of another financial
  institution.  Our ability to establish new branch offices depends on whether
  we can identify advantageous branch office locations and generate new deposits
  and loans from those locations that will create an acceptable level of net
  income.  New branches also typically entail start-up expenses.  Our ability to
  acquire other financial institutions or branches depends on whether we can
  identify, acquire and integrate such institutions or branches.  We cannot
  assure you that we will be able to generate growth or identify attractive
  acquisition candidates, acquire such candidates on favorable terms or
  successfully integrate any acquired institutions or branches.

  THE EXPENSE AND DILUTIVE EFFECT OF THE CONTRIBUTION OF SHARES TO THE
  CHARITABLE FOUNDATION

       We are establishing a charitable foundation in connection with the Stock
  Conversion and  contributing up to 150,000 shares of common stock to the
  Foundation.  The contribution to the Foundation will reduce our earnings in
  1999, the fiscal year in which the Foundation is to be established and the
  contribution made, by up to $2.0 million.  If the Foundation had been
  established and the contribution made during the year ended September 30,
  1998, we would have reported net income of approximately $541,000 rather than
  reporting net income of approximately $2.5 million, for the year ended
  September 30, 1998.  In addition, due to the contribution of shares to the
  Foundation, persons purchasing shares in the Offering will have their
  ownership and voting interests in the Company diluted.  The number of shares
  of common stock to be contributed to the Foundation will equal between 7.0%
  and 10.5% of the shares that will be outstanding following the Conversion at
  the maximum, as adjusted and minimum, respectively, of the Estimated Valuation
  Range.  See "The Conversion -- Establishment of the Charitable Foundation."

  DEPENDENCE ON MARKET AREA

       Our market area consists of Alamance County in North Carolina.  We
  estimate that more than 90% of deposits and loans come from our market area.
  Despite recent diversification, the economy in Alamance County continues to be
  heavily dependent on the textile industry.  A downturn in the textile industry
  could adversely affect the economy in Alamance County, which could adversely
  affect our earnings and reduce the demand for loans and deposits.

  STRONG COMPETITION WITHIN OUR MARKET AREA

       Competition in the banking and financial services industry is intense.
  We compete with commercial banks, savings and loan associations, credit
  unions, finance companies, mutual funds, insurance companies, and brokerage
  and investment banking firms.  Many of these competitors have substantially
  greater resources and lending limits than we do and may offer certain services
  that we do not or cannot provide.  Our profitability depends upon our
  continued ability to successfully compete.

  ANTI-TAKEOVER PROVISIONS AND STATUTORY PROVISIONS THAT COULD DISCOURAGE
  HOSTILE ACQUISITIONS OF CONTROL

       Provisions in the Company's Articles of Incorporation and Bylaws, the
  Virginia Stock Corporation Act, and certain federal regulations may make it
  difficult, and expensive, to pursue a tender offer, change in control or
  takeover attempt that our Board of Directors opposes.  As a result, you may
  not have an opportunity to participate in such a transaction.  Such provisions
  will also render the removal of our current Board of Directors or management
  more difficult.  In addition, these provisions may reduce the trading price of
  our stock.  These provisions include:  restrictions on the acquisition of the
  Company's equity securities and limitations on voting rights; the
  classification of the terms of 

                                       2
the members of the Board of Directors; certain provisions relating to meetings
  of stockholders; denial of cumulative voting by stockholders in the election
  of directors; the possible issuance of preferred stock and additional shares
  of common stock without shareholder approval; and super-majority provisions
  for the approval of certain business combinations. See "Certain Restrictions
  on Acquisition of the Company and the Converted Bank."

  POSSIBLE VOTING CONTROL BY DIRECTORS AND OFFICERS

       The proposed purchases of common stock by our directors and officers, our
  ESOP and our restricted stock plan, if implemented (estimated to be
  approximately 635,500 shares, or 38.5% of the shares to be sold at the
  midpoint of the Estimated Valuation Range), as well as the potential
  acquisition of common stock through stock benefit plans, could make it
  difficult to obtain majority support for stockholder proposals which are
  opposed by management.  In addition, the voting of those shares could enable
  management to block the approval of transactions (i.e., business combinations
  and amendments to our Articles of Incorporation and Bylaws) requiring the
  approval of 80% of the stockholders.  See "Management of the Bank -- Executive
  Compensation -- Employee Stock Ownership Plan," " -- Proposed Future Stock
  Benefit Plans -- Stock Option Plan," " -- Management Recognition Plan,"
  "Description of Capital Stock" and "Certain Restrictions on Acquisition of the
  Company and the Converted Bank."

  POTENTIAL COST OF  FUTURE EMPLOYEE STOCK BENEFIT PLANS

       It is anticipated that the ESOP will purchase 8% of the common stock
  issued in the Stock Conversion, including shares contributed to the
  Foundation, with funds borrowed from the Company.  The cost of acquiring the
  ESOP shares will be between $2.3 million, and $3.4 million.  We will record
  annual ESOP expenses in an amount equal to the fair value of shares committed
  to be released to employees.  If shares of common stock appreciate in value
  over time, compensation expense relating to the ESOP may increase.  In
  addition, it is possible that we will implement a restricted stock plan, under
  which officers and directors could be awarded (at no cost to them) up to an
  aggregate of 4% of the shares issued in the Stock Conversion, including shares
  contributed to the Foundation.  Assuming the shares of common stock to be
  awarded under the plan cost the Purchase Price of $20.00 per share, the
  reduction to stockholders' equity of funding the plan would be between $1.1
  million and $1.7 million.

  POSSIBLE DILUTIVE EFFECT OF EMPLOYEE STOCK BENEFIT PLANS

       If the Conversion is completed and stockholders subsequently approve a
  restricted stock plan and a stock option plan, we will issue stock to our
  officers and directors through these plans.  If the shares for the restricted
  stock plan are issued from our authorized but unissued stock, your ownership
  percentage could be diluted by up to approximately 4% and the trading price of
  our stock may be reduced.  See "Pro Forma Data," "Management of the Bank --
  Proposed Future Stock Benefit Plans -- Stock Option Plan," and "-- Management
  Recognition Plan."  These plans will also involve additional expense.  See "--
  Anticipated Low Return on Equity Following Conversion."

  VALUATION NOT INDICATIVE OF FUTURE PRICE OF COMMON STOCK

       The final aggregate purchase price of the common stock in the Stock
  Conversion will be based upon an independent appraisal. The appraisal is not
  intended, and should not be construed, as a recommendation of any kind as to
  the advisability of purchasing shares of common stock. The valuation is based
  on estimates and projections of a number of matters, all of which are subject
  to change from time to time. We cannot assure you that if you purchase common
  stock in the Offering for $20.00 per share you will later be able to sell it
  at or above that price. See "The Conversion -- Stock Pricing and Number of
  Shares to be Issued."

                                       3
POSSIBLE ADVERSE TAX CONSEQUENCES OF THE SUBSCRIPTION RIGHTS

       Should the IRS determine that the subscription rights have ascertainable
  value, you could be taxed as a result of your exercise of such rights in an
  amount equal to such value.  We have received the opinion of Ferguson that the
  subscription rights granted to eligible members in connection with the Stock
  Conversion have no value.  This opinion is not binding on the Internal Revenue
  Service ("IRS"), however.

  RECENT STOCK MARKET VOLATILITY

       Publicly traded stocks, including stocks of financial institutions, have
  recently experienced substantial market price volatility.  These market
  fluctuations may be unrelated to the operating performance of particular
  companies whose shares are traded.  In several cases, common stock issued by
  recently converted financial institutions has traded at a price that is below
  the price at which such shares were sold in the initial offerings of those
  companies.  The purchase price of our common stock in the offering is based on
  the independent appraisal by Ferguson.  After our shares begin trading, the
  trading price of our common stock will be determined by the marketplace, and
  may be influenced by many factors, including prevailing interest rates,
  investor perceptions of the Company and general industry and economic
  conditions.  Due to possible continued market volatility and to other factors,
  including certain Risk Factors discussed in this document, there can be no
  assurance that, following the Stock Conversion, the trading price of our
  common stock will be at or above the $20.00 per share initial offering price.

  NO OPINION OR RECOMMENDATION BY SALES AGENT; BEST EFFORTS OFFERING

       We have engaged Trident Securities to consult with and advise us with
  respect to the Stock Conversion and to assist, on a best-efforts basis, in
  connection with the solicitation of subscriptions and purchase orders for
  shares of common stock in the Offering.  Trident Securities has not prepared
  or delivered any opinion or recommendation with respect to the suitability of
  the common stock or the appropriateness of the amount of common stock to be
  issued in the Stock Conversion.  The engagement of Trident Securities by us
  and the work performed pursuant to such engagement, including any due
  diligence investigation, should not be construed by purchasers of the common
  stock as constituting an opinion or recommendation relating to investment in
  the common stock offered by this document.

  IMPACT OF TECHNOLOGICAL ADVANCES; YEAR 2000 COMPLIANCE

       Our industry is experiencing rapid changes in technology.  Technology-
  driven products and services are frequently introduced.  In addition to
  improving customer services, effective use of technology increases efficiency
  and enables financial institutions to reduce costs.  Our future success will
  thus depend partly on our ability to address our customers' needs by using
  technology.  Many of our competitors have far greater resources than we have
  to invest in technology.  We cannot assure you that we will be able to
  effectively develop new technology-driven products and services or be
  successful in marketing these products to our customers.

       Our operations are also dependent on computers and computer systems,
  whether we maintain them internally or they are maintained by a third party.
  Systems that do not properly recognize the correct year could produce faulty
  data or cause a system to fail.  Such failures may include, among other
  things, the inability to process and underwrite loan applications, to credit
  deposits and withdrawals from customer accounts, to credit loan payments or
  track delinquencies, to properly reconcile and record daily activity or to
  engage in similar normal banking activities.  Additionally, if our commercial
  customers are not Year 2000 compliant and suffer adverse effects on their
  operations, their ability to meet their obligations to us could be adversely
  affected.   We cannot assure you that we, our customers and our third party
  providers will be successful in making all necessary changes to avoid computer
  system failures related to the year 2000.  For a further discussion of our
  efforts to prepare for Year 2000 issues, see "Management's Discussion and
  Analysis of Financial Condition and Results of Operations -- Year 2000
  Compliance."

                                       4
EFFECT OF REGULATORY CHANGES ON OPERATIONS

       We are subject to extensive regulation, supervision and examination by
  the Administrator and the FDIC.  Following the Conversion, the Converted Bank
  will be subject to the regulation and supervision of the Commission and the
  FDIC, and the Company will be subject to regulation and supervision by the
  Federal Reserve Board.  The regulatory authorities have extensive discretion
  in connection with their supervisory and enforcement activities.  Any change
  in regulation, whether by the Commission, the FDIC, the Federal Reserve Board
  or the U.S. Congress, could have a significant impact on us and our
  operations.

       There is legislation pending in the U.S. Congress that calls for the
  modernization of the banking system and that would significantly affect the
  operations and regulatory structure of the financial services industry.   At
  this time, we do not know what form the final legislation might take, but if
  enacted into law, the legislation could affect our competitive environment as
  well as our business and operations.  See "Regulation --Depository Institution
  Regulation -- Proposed Legislative and Regulatory Changes."

  RISK OF LOSS OF PRINCIPAL

       The shares of common stock offered by this document are not savings
  accounts or deposits and are not insured or guaranteed by the FDIC, the SAIF
  or any other governmental agency, and involve investment risk, including the
  possible loss of principal.

                                       5
PROPOSED MANAGEMENT PURCHASES

       The following table sets forth the approximate purchases of common stock
  by each director and executive officer and their associates.  The table
  assumes that 1,500,000 shares of the common stock, the midpoint of the
  Estimated Valuation Range, will be sold at $20.00 per share, that 150,000
  shares are issued to the Foundation and that sufficient shares will be
  available to satisfy subscriptions in all categories.
Percent       Aggregate Purchase
                                                         Total      of Total           Price of
Name and Position                                        Shares   Outstanding (1)  Proposed Purchases
-----------------                                        -------  ---------------  ------------------
James A. Barnwell, Jr., Director                        50,000       3.0%         $ 1,000,000
  Bernie C. Bean, Director                                25,000       1.5              500,000
  Richard C. Keziah, Chairman of the Board                47,500       2.9              950,000
  James G. McClure, Director                              50,000       3.0            1,000,000
  James C. McGill, President, Chief Executive             50,000       3.0            1,000,000
      Officer and Director
  T. Scott Quakenbush, Director                           50,000       3.0            1,000,000
  Richard H. Shirley, Director                            37,500       2.3              750,000
  Virgil L. Stadler, Director                             50,000       3.0            1,000,000
  A. Christine Baker, Executive Vice President-
      Chief Financial Officer                             32,500       2.0              650,000
  Fairfax C. Reynolds, Executive Vice President-
     Commercial & Retail Banking                          32,500       2.0              650,000
  John D. Hansell, Manager-First Capital Services LLC      2,500        .2               50,000
  Frank Gavigan, Senior Vice President-Senior             10,000        .6              200,000
    Credit Officer
 
  All directors and executive officers, as a
    group (12 persons) and their associates              437,500      26.5            8,750,000
 
  ESOP                                                   132,000       8.0            2,640,000
  MRP  (2)                                                66,000       4.0            1,320,000
                                                         -------      ----          -----------
       Total (3)                                         635,500      38.5%         $12,710,000
                                                         =======      ====          ===========
____________________
(1)  Percentages are based on the sale of 1,500,000 shares at the midpoint of
     the Estimated Valuation Range and the issuance of 150,000 shares to the
     Foundation.

(2)  Consists of shares that are expected to be awarded to participants in the
     MRP, if implemented. The dollar amount of the common stock to be purchased
     by the MRP is based on the Purchase Price in the Offering and does not
     reflect possible future increases or decreases in the value of such stock.
     See "Management of the Bank -- Proposed Future Stock Benefit Plans --
     Management Recognition Plan." Such shares could be newly issued shares or
     shares purchased in the open market in the sole discretion of the Company's
     Board of Directors. The percentage shown assumes the shares are purchased
     in the open market. Any sale of newly issued shares to the MRP would be
     dilutive to existing stockholders. See "Risk Factors -- Possible Dilutive
     Effect of Future Employee Stock Benefit Plans."

(3)  Does not include shares that possibly would be purchased by participants in
     a stock option plan, intended to be implemented, under which directors,
     executive officers and other employees would be granted options to purchase
     an aggregate amount of common stock equal to 10% of the shares issued in
     the Stock Conversion, including shares contributed to the Foundation at
     exercise prices equal to the market price of the common stock on the date
     of grant. See "Management of the Bank --Proposed Future Stock Benefit 
     Plans -- Stock Option Plan."

                                       6
USE OF PROCEEDS

       The net proceeds from the sale of the common stock are estimated to be
  between $24.5 million at the minimum of the Offering range, and $38.5 million
  at the maximum, as adjusted of the Offering range.  The Company will purchase
  all of the capital stock of the Converted Bank in exchange for 50% of the net
  proceeds after deducting the cost of the ESOP loan.  Assuming the sale of
  $30.0 million of common stock at the midpoint of the Estimated Valuation Range
  and the purchase of 8% of the shares to be issued in the Stock Conversion,
  including shares contributed to the Foundation, by the ESOP, the Bank would
  receive approximately $13.2 million in cash, and the Company would retain
  approximately $13.2 million in cash and $2.6 million in the form of a note
  receivable from the ESOP.

       The proceeds retained by the Company, after making the loan to the ESOP,
  initially will be invested in short-term and intermediate-term securities,
  including cash and cash equivalents and U.S. Government and agency
  obligations.  The proceeds will be available for a variety of corporate
  purposes, including funding a restricted stock plan, if implemented, future
  acquisitions and diversification of business, additional capital contributions
  to the Converted Bank, dividends to stockholders and future repurchases of
  common stock.  We do not have any specific plans, intentions, arrangements or
  understandings regarding acquisitions, capital contributions or repurchases.
  In addition, such funds will be available to be loaned to the Bank, if
  necessary, in the event and to the extent loan growth exceeds deposit growth
  or for other corporate purposes.  A portion of the net proceeds may be used to
  acquire shares of common stock pursuant to a restricted stock plan, if
  implemented or to purchase shares to be held by a grantor trust for issuance
  to option holders upon the exercise of options in the event a stock option
  plan is implemented.  See "Management of the Bank -- Proposed Future Stock
  Benefit Plans -- Stock Option Plan" and "-- Management Recognition Plan."  We
  do not have any specific plans regarding possible stock repurchases during the
  first year following the Stock Conversion.

       The proceeds contributed to the Converted Bank will ultimately become
  part of the Converted Bank's general corporate funds to be used for its
  business activities, including making loans and investments.  Initially, it is
  expected that the proceeds will be invested in short-term and intermediate-
  term securities including cash and cash equivalents and U.S. Government and
  agency obligations.  The Converted Bank ultimately plans to use such proceeds
  primarily to originate loans in the ordinary course of business.

                                DIVIDEND POLICY

       The payment of cash dividends on the common stock will be subject to the
  requirements of applicable law.  In addition, the determination of whether to
  pay dividends is made by the Board of Directors.  The Board will take into
  account, among other things, our net income, capital and financial condition,
  industry trends and general economic conditions.  We intend to establish a
  quarterly cash dividend following the Conversion at an initial quarterly rate
  of approximately $.10 per share (or an annual rate of $.40 per share, or
  approximately 2.0% based on the $20.00 per share Purchase Price), commencing
  during the first full calendar quarter subsequent to the Stock Conversion.  In
  addition, from time to time in an effort to manage capital to a reasonable
  level, the Board may determine if it is prudent to pay periodic special cash
  dividends.  Periodic special cash dividends, if paid, may be paid in addition
  to, or in lieu of, regular cash dividends.  There can be no assurance that
  regular cash dividends or periodic special cash dividends will be paid or
  that, if paid, will continue to be paid.

       Dividend payments by the Company are subject to regulatory restrictions
  under Federal Reserve Board policy as well as to limitations under applicable
  provisions of Virginia corporate law.  The Federal Reserve Board has issued a
  policy statement on the payment of cash dividends by bank holding companies,
  which expresses the Federal Reserve Board's view that a bank holding company
  should pay cash dividends only to the extent that the company's net income for
  the past year is sufficient to cover both the cash dividends and a rate of
  earning retention that is consistent with the company's capital needs, asset
  quality and overall financial condition.  The Federal Reserve Board also
  indicated that it would be inappropriate for a company experiencing serious
  financial problems to borrow funds to pay dividends.  Furthermore, the Federal
  Reserve Board may prohibit a bank holding company from paying any dividends if
  the holding company's bank subsidiary is classified as "undercapitalized".
  See "Regulation -- Regulation of the Company Following 

                                       7
the Bank Conversion --Dividends." Under Virginia law, dividends may not be
  paid only if payment of a dividend would cause the Company to be unable to pay
  its debts as they become due or would result in total assets being less than
  the sum of total liabilities plus any amount required to be paid to holders of
  preferred stock in the event of liquidation of the Company.

       We have agreed with the FDIC not to make a tax-free cash distribution to
  stockholders for a period of one year following consummation of the Stock
  Conversion.  In addition, we have agreed with the FDIC not to file a private
  letter ruling request with the Internal Revenue Service regarding the tax-free
  nature of a possible one-time cash distribution to Company stockholders for a
  period of one year following consummation of the Stock Conversion.

       Because the Company initially will have no significant source of income
  other than dividends from the Converted Bank and earnings from investment of
  the net proceeds of the Offering retained by the Company, the payment of
  dividends by the Company will depend in part upon the receipt of dividends
  from the Converted Bank, which is subject to various tax and regulatory
  restrictions.  See "Regulation -- Depository Institution Regulation --
  Dividend Restrictions."

                          MARKET FOR THE COMMON STOCK

       The Company has never issued capital stock to the public.  Consequently,
  there is no established market for the common stock.  We have received
  conditional approval to have the common stock listed on the Nasdaq National
  Market under the symbol "_____".  For initial inclusion for listing on Nasdaq,
  the Company must have three active and registered market makers.  Trident
  Securities has advised us that it will act as a market maker for the common
  stock, and we expect that additional market makers will be identified.  The
  development of a liquid public market depends on the existence of willing
  buyers and sellers, the presence of which is not within our control, and the
  number of active buyers and sellers of the common stock at any particular time
  may be limited.  Under such circumstances, you could have difficulty disposing
  of your shares and should view the common stock as a long-term investment.  We
  cannot assure you that an active and liquid trading market for the common
  stock will develop, or, if developed, it will continue, or that you will be
  able to sell your shares at or above the $20.00 Purchase Price.

                                       8
CAPITALIZATION

       The following table sets forth our historical capitalization, including
  deposits, at September 30, 1998 and our pro forma consolidated capitalization
  giving effect to the sale of the common stock in the Offering based upon the
  assumptions set forth under "Pro Forma Data" and below.  Depending on market
  and financial conditions, the total number of shares to be issued in the Stock
  Conversion may be significantly increased or decreased above or below the
  midpoint of the Estimated Valuation Range.  We may consummate the Stock
  Conversion without a resolicitation of subscribers and other purchasers if the
  aggregate purchase price of the common stock sold in the Stock Conversion is
  above the minimum of the Estimated Valuation Range or less than 15% above the
  maximum of the Estimated Valuation Range.  A CHANGE IN THE NUMBER OF SHARES TO
  BE ISSUED IN THE STOCK CONVERSION MAY MATERIALLY AFFECT THE COMPANY'S PRO
  FORMA CAPITALIZATION.  SEE "PRO FORMA DATA" AND "THE CONVERSION -- STOCK
  PRICING AND NUMBER OF SHARES TO BE ISSUED."
Pro Forma Consolidated Capitalization of                       
                                    Capitalization           the Company at September 30, 1998 Based on the Sale of              
                                        of the    ---------------------------------------------------------------------------------
                                       Bank at     1,275,000 Shares   1,500,000 Shares     1,725,000 Shares      1,983,750 Shares
                                    September 30,      at $20.00          at $20.00           at $20.00             at $20.00
                                         1998          Per Share          Per Share           Per Share             Per Share
                                    -------------- -----------------  -----------------  --------------------  --------------------
                                                                            (In thousands)
Deposits (1).....................      $235,694          $235,694           $235,694         $235,694              $235,694
  FHLB advances....................        20,000            20,000             20,000           20,000                20,000
                                         --------          --------           --------         --------              --------
      Total deposits and                                                                       
       borrowed funds..............      $255,694          $255,694           $255,694         $255,694              $255,694
                                         ========          ========           ========         ========              ========
                                                                                               
  Capital stock                                                                                
    Preferred stock, $.01 par                                                                  
     value per share:                                                                          
      authorized - 1,000,000                                                                   
       shares;                                                                                 
      assumed outstanding - none...      $     --          $     --           $     --         $     --              $     --
    Common stock, $.01 par value                                                               
     per share:                                                                                
      authorized - 7,000,000                                                                   
       shares;                                                                                 
      shares to be outstanding -                                                               
       as shown, plus 150,000                                                                  
       shares                                                                                  
      issued to Foundation.........            --                14                 17               19                    21
    Paid-in capital (2)............            --            27,508             31,943           36,379                41,481
    Less:  Expense of                                                                          
     contribution to Foundation                                                                
     (3)...........................                          (3,000)            (3,000)          (3,000)               (3,000)
    Plus:  Tax benefit of                                                                      
     contribution to Foundation                                                                
     (4)...........................                           1,020              1,020            1,020                 1,020
    Less:  Common stock acquired                                                               
     by ESOP (5)...................            --            (2,280)            (2,640)          (3,000)               (3,414)
           Common stock                                                                        
            acquired by MRP (6)                --            (1,140)            (1,320)          (1,500)               (1,707)
                                                                                               
    Retained income (7)............        25,873            25,873             25,873           25,873                25,873
    Net unrealized gains on                                                                    
     investment securities                                                                     
     available                                                                                 
        for sale...................            93                93                 93               93                    93
                                         --------          --------           --------         --------              --------
      Total stockholders' equity...      $ 25,966          $ 48,088           $ 51,986         $ 55,884              $ 60,367
                                         ========          ========           ========         ========              ========
(footnotes on following page)

                                       9
(footnotes for table on previous page)

--------------------
(1)  Withdrawals from savings accounts for the purchase of stock have not been
     reflected in these adjustments. Any withdrawals will reduce pro forma
     capitalization by the amount of such withdrawals.

(2)  Based upon the estimated net proceeds from the sale of capital stock less
     the par value of shares sold. Estimated Offering expenses are $978,000,
     $1,040,000, $1,102,000 and $1,173,000 at the minimum, midpoint, maximum and
     maximum, as adjusted of the Estimated Valuation Range. Does not reflect
     additional shares of common stock that possibly could be purchased by
     participants in the stock option plan, if implemented, under which
     directors, executive officers and other employees could be granted options
     to purchase an aggregate of up to 10% of the shares of common stock issued
     in the Stock Conversion, including shares contributed to the Foundation, at
     exercise prices equal to the market price of the common stock on the date
     of grant. Implementation of the stock option plan within one year after the
     Stock Conversion will require regulatory and stockholder approval. See
     "Management of the Bank -- Proposed Future Stock Benefit Plans -- Stock
     Option Plan" and "Risk Factors -- Possible Dilutive Effect of Employee
     Stock Benefit Plans."

(3)  Reflects the issuance of 150,000 shares of common stock to the Foundation
     at an assumed value of $20.00 per share.

(4)  Reflects the tax effect of the contribution of common stock based upon a
     34% marginal federal tax rate. The realization of the deferred tax benefit
     is limited annually to 10% of our annual taxable income, subject to our
     ability to carry forward any unused portion of the deduction for five years
     following the year in which the contribution is made.

(5)  Assumes 8% of the shares of common stock to be sold in the Offering,
     including shares contributed to the Foundation, are purchased by the ESOP
     and that the funds used to purchase such shares are borrowed from the
     Company. See "Pro Forma Data" for additional details.

(6)  Assumes that a number of shares equal to 4% of the number of shares sold in
     the Offering, including shares contributed to the Foundation, will be
     acquired in the open market at the Purchase Price per share ($20.00) for
     the restricted stock plan following implementation of such plan. If the
     restricted stock plan were funded by authorized but unissued shares, your
     interests would be diluted by approximately 4%. Implementation of such a
     plan within one year of the Stock Conversion would require regulatory and
     shareholder approval at a meeting of our stockholders to be held no earlier
     than six months after the Stock Conversion. See "Management of the Bank --
     Proposed Future Stock Benefit Plans -- Management Recognition Plan."

(7)  The retained income of the Bank is substantially restricted. All capital
     distributions by the Bank are subject to regulatory restrictions tied to
     its regulatory capital level. In addition, after the Stock Conversion, the
     Bank will be prohibited from paying any dividend that would reduce its
     regulatory capital below the amount in the liquidation account to be
     provided for the benefit of the Bank's Eligible Account Holders and
     Supplemental Eligible Account Holders at the time of the Stock Conversion
     and adjusted downward thereafter. See "Regulation -- Depository Institution
     Regulation -- Dividend Restrictions" and "The Conversion -- Effect of
     Conversion to Stock Form on Depositors and Borrowers of the Bank --
     Liquidation Account."

                                       10
HISTORICAL AND PRO FORMA REGULATORY CAPITAL COMPLIANCE

     We are subject to North Carolina law, which requires that net worth,
computed in accordance with the requirements of the Administrator, equal or
exceed 5% of total assets. In addition, we are subject to the capital
requirements of the FDIC. The FDIC requires that institutions which receive the
highest rating during their examination process and are not experiencing or
anticipating significant growth must maintain a leverage ratio of Tier 1 capital
to "total assets" (as defined in FDIC regulations) of at least 3%. All other
institutions are required to maintain a ratio of 1% or 2% above the 3% minimum
with an absolute minimum leverage ratio of not less than 4%. The FDIC also
imposes requirements that (i) the ratio of Tier 1 capital to risk-weighted
assets equal at least 4%, and (ii) the ratio of total capital to risk-weighted
assets equal at least 8%.

     After the Bank Conversion, the Converted Bank will continue to be subject
to the FDIC's capital requirements and the Company will be required to satisfy
Federal Reserve Board capital requirements, which are similar but not identical
to the FDIC's capital requirements. The following table sets forth our
historical capital position relative to the various minimum Administrator and
FDIC capital regulatory requirements to which we are currently subject. The next
table sets forth our historical capital position and thereafter presents pro
forma data relative to such Federal Reserve Board capital requirements to which
the Converted Bank will be subject. For additional information regarding our
financial condition and the assumptions underlying the pro forma capital
calculations set forth below, see "Use of Proceeds," "Capitalization" and "Pro
Forma Data" and the consolidated financial statements and related notes
appearing elsewhere in this Prospectus.
Historical at
                                                         September 30, 1998
                                                         --------------------
                                                                   Percent of
                                                         Amount    Assets(1)
                                                         ------    ----------
                                                        (Dollars in thousands)
Tier 1/leverage capital........................          $25,873    9.13%
Tier 1/leverage capital requirement                       11,334    4.00
                                                         -------   -----
 Excess                                                  $14,539    5.13%
                                                         =======   =====
                                                                   
Tier 1 risk-based capital......................          $25,873   14.53%
Tier 1 risk-based capital requirement                      7,124    4.00 
                                                         -------   -----
 Excess                                                  $18,749   10.53%
                                                         =======   =====
                                                                   
Total risk-based capital.......................          $28,112   15.78%
Total risk-based capital requirement                      14,249    8.00
                                                         -------   -----
 Excess                                                  $13,863    7.78%
                                                         =======   ===== 
                                                                   
North Carolina regulatory capital..............          $28,112    9.75%
North Carolina regulatory capital requirement             14,411    5.00
                                                         -------   -----
 Excess                                                  $13,701    4.75%
                                                         =======   =====
--------------------
(1)  The ratio of leverage capital is based on quarterly average assets for the
     year ended September 30, 1998. Tier 1 risk-based capital and total risk-
     based capital is based on risk-weighted assets at September 30, 1998. The
     North Carolina regulatory capital requirement is based on total assets at
     September 30, 1998.

                                       11
Bank's Historical   Pro Forma Capital of the Converted  Bank as of September 30, 1998 Based on the Sale of (1):
                   Capital at September  -------------------------------------------------------------------------------------------
                    30, 1998 Assuming     1,275,000 Shares   1,500,000 Shares     1,725,000 Shares     1,983,750 Shares            
                   Federal Reserve Board     at $20.00          at $20.00            at $20.00            at $20.00               
                   Capital Requirements      Per Share          Per Share            Per Share            Per Share               
                   --------------------- ------------------- ----------------- ------------------- -------------------            
                            Percent of            Percent of         Percent of         Percent of         Percent of  
                   Amount   Assets (2)   Amount   Assets (2) Amount  Assets (2) Amount  Assets (2) Amount  Assets (2)             
                   ------   ----------   ------   ---------- ------  ---------  ------  ---------- ------  ----------             
                                                                 (Dollars in  thousands)
Capital under 
 generally 
  accepted 
   accounting                                                                                                              
    principles...  $25,966      9.0%     $37,087    12.4%   $39,126    13.0%    $41,165      13.6% $43,510      14.2%  
                   =======      ====     =======    ====    =======    ====     =======      ====  =======      ====   
Tier 1 (core) to 
 total assets....  $25,873      9.0%     $36,994    12.4%   $39,033    13.0%    $41,072      13.5% $43,417      14.2% 
Tier 1 (core)                         
 capital                              
  requirement                         
  (3)............   11,555      4.0       11,970     4.0     12,052     4.0      12,133       4.0   12,227       4.0  
                   -------     ----      -------    ----    -------    ----     -------      ----  -------      ----  
   Excess........  $14,318      5.0%     $25,024     8.4%   $26,981     9.0%    $28,939       9.5% $31,190      10.2% 
                   =======     ====      =======    ====    =======    ====     =======      ====  =======      ====  
                                                                                                                                 
Tier 1 (core)                         
 capital to                                                                                                         
  risk-weighted                       
   assets........  $25,873     14.5%     $36,994    20.1%   $39,033    21.1%    $41,072      22.1% $43,417      23.2% 
Tier 1 (core)                         
 capital                                                                                                            
  requirement....    7,124      4.0        7,347     4.0      7,388     4.0       7,428       4.0    7,475       4.0  
                   -------     ----      -------    ----    -------    ----     -------      ----  -------      ----  
   Excess........  $18,749     10.5%     $29,647    16.1    $31,645    17.1%    $33,644      18.1% $35,942      19.2% 
                   =======     ====      =======    ====    =======    ====     =======      ====  =======      ====  
                                                                                                                                 
Total capital to                                                                                                                 
 risk-weighted                        
  assets.........  $28,112     15.8%     $39,233    21.4%   $41,272    22.3%    $43,311      23.3% $45,656      24.4% 
Total capital                         
 requirement.....   14,249      8.0       14,694     8.0     14,775     8.0      14,857       8.0   14,951       8.0  
                   -------     ----      -------    ----    -------    ----     -------      ----  -------      ----  
   Excess........  $13,863      7.8%     $24,539    13.4%   $26,497    14.3%    $28,454      15.3% $30,705      16.4% 
                   =======     ====      =======    ====    =======    ====     =======      ====  =======      ====
--------------------
     (1)  Assumes the Company will purchase all of the capital stock of the
          Converted Bank to be issued in the Stock Conversion in exchange for
          50% of the net proceeds. Assumes net proceeds distributed to the
          Company or the Converted Bank initially are invested in assets with a
          50% risk-weighting. The numbers of shares sold do not include the
          150,000 shares to be contributed to the Foundation.

     (2)  Based on our total assets for capital as determined under generally
          accepted accounting principles and Tier 1 capital purposes, and risk-
          weighted assets for the purpose of the risk-based capital
          requirements.

     (3)  Assumes a core capital requirement of 4% adjusted total assets, though
          such level may be increased by the Federal Reserve Board to as high as
          5%. See "Regulation -- Depository Institution Regulation -- Capital
          Requirements."

                                       12
PRO FORMA DATA

     The actual net proceeds from the sale of the common stock cannot be
determined until the Stock Conversion is completed.  However, investable net
proceeds are currently estimated to be between $21.1 million and $33.4 million
at the minimum and maximum as adjusted, of the Estimated Valuation Range,
based upon the following assumptions (i) 100% of the shares of common stock
will be sold in the Subscription and Community Offerings and the Syndicated
Community Offering as follows, with the exception of shares being contributed
to the Foundation, for which no proceeds will be received and no commissions
will be paid:  (a) 132,000 shares will be sold to the ESOP and 437,500 shares
will be sold to directors and officers of the Bank and their associates and to
employees, for which commissions will not be paid; and (b) the remaining
shares will be sold to others in the Subscription and Community Offerings; and
(ii) other Conversion expenses, not including sales commissions, will be
approximately $761,000.

     The following table sets forth our historical net earnings and
stockholders' equity prior to the Stock Conversion and our pro forma
consolidated net income and stockholders' equity following the Stock
Conversion.  Pro forma consolidated net income and stockholders' equity have
been calculated as if the common stock to be issued in the Stock Conversion
had been sold at October 1, 1997, and the estimated net proceeds had been
invested at 4.50%, which was approximately equal to the one-year U.S. Treasury
bill rate at September 30, 1998.  We used the one-year U.S. Treasury bill
rate, rather than an arithmetic average of the average yield on interest-
earning assets and average rate paid on deposits, to estimate income on net
proceeds because we believe that this is a more accurate estimate of the rate
that would be obtained on an investment of net proceeds from the Offering.  In
calculating pro forma income, an effective state and federal income tax rate
of 36.0% has been assumed, resulting in an after tax yield of 2.88%.
Withdrawals from deposit accounts for the purchase of shares are not reflected
in the pro forma adjustments.  As discussed under "Use of Proceeds," the
Company expects to retain a portion of the net Offering proceeds, part of
which will be loaned to the ESOP to fund its purchase of 8% of the shares
issued, including shares contributed to the Foundation, in the Stock
Conversion.  No effect has been given in the pro forma stockholders' equity
calculation for the assumed earnings on the net proceeds. Historical and pro
forma per share amounts have been calculated by dividing historical and pro
forma amounts by the indicated number of shares.

     THE STOCKHOLDERS' EQUITY AND RELATED DATA PRESENTED HEREIN ARE NOT INTENDED
TO REPRESENT THE FAIR MARKET VALUE OF THE COMMON STOCK, THE CURRENT VALUE OF
ASSETS OR LIABILITIES, OR THE AMOUNTS, IF ANY, THAT WOULD BE AVAILABLE FOR
DISTRIBUTION TO STOCKHOLDERS IN THE EVENT OF LIQUIDATION. FOR ADDITIONAL
INFORMATION REGARDING THE LIQUIDATION ACCOUNT, SEE "THE CONVERSION -- EFFECT OF
CONVERSION TO STOCK FORM ON DEPOSITORS AND BORROWERS OF THE BANK --LIQUIDATION
ACCOUNT." THE PRO FORMA INCOME AND RELATED DATA DERIVED FROM THE ASSUMPTIONS SET
FORTH ABOVE SHOULD NOT BE CONSIDERED INDICATIVE OF OUR ACTUAL RESULTS OF
OPERATIONS FOR ANY CURRENT OR FUTURE PERIOD. SUCH PRO FORMA DATA MAY BE
MATERIALLY AFFECTED BY A CHANGE IN THE NUMBER OF SHARES TO BE ISSUED IN THE
STOCK CONVERSION AND OTHER FACTORS. SEE "THE CONVERSION -- STOCK PRICING AND
NUMBER OF SHARES TO BE ISSUED." THE FOLLOWING TABLE DOES NOT REFLECT THE AFTER-
TAX EXPENSE OF $2.0 MILLION WE WILL INCUR DURING THE YEAR ENDING SEPTEMBER 30,
1999 AS A RESULT OF OUR CONTRIBUTION OF 150,000 SHARES OF COMMON STOCK TO THE
FOUNDATION.

                                       13
At or for the Year Ended September 30, 1998
                                                      --------------------------------------------------------------
                                                       1,275,000          1,500,000        1,725,000       1,983,750
                                                         Shares             Shares           Shares          Shares
                                                       at $20.00          at $20.00        at $20.00       at $20.00
                                                       Per Share          Per Share        Per Share       Per Share
                                                       ---------          ---------        ---------       ---------
                                                               (Dollars in thousands, except per share amounts)
Gross offering proceeds...........................    $   25,500         $   30,000       $   34,500      $   39,675
Plus: Shares issued to Foundation.................         3,000              3,000            3,000           3,000
                                                      ----------         ----------       ----------      ----------
  Pro Forma market capitalization.................    $   28,500         $   33,000       $   37,500      $   42,675
                                                      ==========         ==========       ==========      ==========
                                           
Gross offering proceeds...........................    $   25,500         $   30,000       $   34,500      $   39,675
Less estimated offering expenses..................          (978)            (1,040)          (1,102)         (1,173)
                                                      ----------         ----------       ----------      ----------
  Estimated net offering proceeds.................    $   24,522         $   28,960       $   33,398      $   38,502
Less:  ESOP funded by the Company.................        (2,280)            (2,640)          (3,000)         (3,414)
       MRP........................................        (1,140)            (1,320)          (1,500)         (1,707)
                                                      ----------         ----------       ----------      ----------
  Estimated investable net proceeds...............    $   21,102         $   25,000       $   28,898      $   33,381
                                                      ==========         ==========       ==========      ==========
                                           
Net income:                                
  Historical net income...........................    $    2,521         $    2,521       $    2,521      $    2,521
  Pro forma income on investable net proceeds.....           608                720              832             961
  Pro forma ESOP adjustment (1)...................          (146)              (169)            (192)           (218)
  Pro forma MRP adjustment (2)....................          (146)              (169)            (192)           (218)
                                                      ----------         ----------       ----------      ----------
      Total.......................................    $    2,837         $    2,903       $    2,969      $    3,046
                                                      ==========         ==========       ==========      ==========
   
 Net income per share:
   Historical net income..........................    $     1.91         $     1.65       $     1.45      $     1.27
   Pro forma income on investable net proceeds....          0.46               0.47             0.48            0.49
   Pro forma ESOP adjustment (1)..................         (0.11)             (0.11)           (0.11)          (0.11)
   Pro forma MRP adjustment (2)...................         (0.11)             (0.11)           (0.11)          (0.11)
                                                      ----------         ----------       ----------      ----------
     Total........................................    $     2.15         $     1.90       $     1.71      $     1.54
                                                      ==========         ==========       ==========      ==========
 
Weighted average number of shares outstanding
 for earnings per share calculations (1)..........     1,322,400          1,531,200        1,740,000       1,980,120
 
Stockholders' equity: (3)
  Historical......................................    $   25,966         $   25,966       $   25,966      $   25,966
  Estimated net proceeds (2)(4)...................        24,522             28,960           33,398          38,502
  Plus: Shares issued to Foundation...............         3,000              3,000            3,000           3,000
  Less: Contribution to Foundation................        (3,000)            (3,000)          (3,000)         (3,000)
  Plus:  Tax benefit of the contribution         
         to the  Foundation.......................         1,020              1,020            1,020           1,020
  Less:   Common stock acquired by ESOP (1).......        (2,280)            (2,640)          (3,000)         (3,414)
          Common stock acquired by MRP (2)........        (1,140)            (1,320)          (1,500)         (1,707)
                                                      ----------         ----------       ----------      ----------
     Total........................................    $   48,088         $   51,986       $   55,884      $   60,367
                                                      ==========         ==========       ==========      ==========
                                                 
Stockholders' equity per share: (3)              
  Historical......................................    $    18.22         $    15.74       $    13.85      $    12.17
  Estimated net proceeds (2)(4)...................         17.21              17.55            17.81           18.04
  Plus: Shares issued to Foundation...............          2.11               1.82             1.60            1.41
  Less: Contribution to Foundation................         (2.11)             (1.82)           (1.60)          (1.41)
  Plus: Tax benefit of the contribution          
        to the  Foundation........................          0.72               0.62            0. 54            0.48
  Less:   Common stock acquired by ESOP (1).......         (1.60)             (1.60)           (1.60)          (1.60)
          Common stock acquired by MRP (2)........         (0.80)             (0.80)           (0.80)          (0.80)
                                                      ----------         ----------       ----------      ----------
     Total........................................    $    33.75         $    31.51       $    29.80      $    28.29
                                                      ==========         ==========       ==========      ==========
 
Number of shares outstanding for
 stockholders' equity per share calculations......     1,425,000          1,650,000        1,875,000       2,133,750
 
Offering price as a percentage of pro forma
 stockholders' equity per share...................          59.3%              63.5%            67.1%           70.7%
                                                      ==========         ==========       ==========      ==========
 
Ratio of offering price to pro forma
 net income per share.............................           9.3x              10.5x            11.7x           13.0x
                                                      ==========         ==========       ==========      ==========

                                                                                          (Footnotes on succeeding page)
14
-------------------------
(1)       Assumes the ESOP purchases 8% of the shares to be sold in the Stock
          Conversion, including shares contributed to the Foundation, and that
          the Company lends the ESOP the funds to do so. The approximate amount
          expected to be borrowed by the ESOP is not reflected as a liability
          but is reflected as a reduction of capital. Although repayment of such
          debt will be secured solely by the shares purchased by the ESOP, the
          Converted Bank expects to make discretionary contributions to the ESOP
          in an amount at least equal to the principal and interest payments on
          the ESOP debt. Pro forma net income has been adjusted to give effect
          to such contributions, based upon a fully amortizing debt with a ten-
          year term. Because the Company will be providing the ESOP loan, only
          principal payments on the ESOP loan are reflected as employee
          compensation and benefits expense. The Purchase Price of $20.00 was
          utilized to calculate the ESOP expense. The Bank intends to record
          compensation expense related to the ESOP in accordance with AICPA SOP
          No. 93-6. As a result, to the extent the value of the common stock
          appreciates over time, compensation expense related to the ESOP will
          increase. SOP 93-6 and SFAS No. 128 require the earnings per share
          computations for companies with leveraged ESOPs to include as
          outstanding only shares that have been committed to be released to
          participants. The table assumes that 10% of the ESOP shares purchased
          in the Stock Conversion were committed to be released. See "Management
          of the Bank -- Executive Compensation -- Employee Stock Ownership
          Plan.
(2)       Assumes a number of shares of common stock equal to 4% of the common
          stock to be sold in the Stock Conversion, including shares contributed
          to the Foundation, will be purchased by a restricted stock plan (the
          "MRP") in the open market following the Stock Conversion. The dollar
          amount of the common stock to be purchased by the MRP is based on the
          Purchase Price in the Stock Conversion and represents unearned
          compensation and is reflected as a reduction of capital. Such amount
          does not reflect possible increases or decreases in the value of such
          stock relative to the Purchase Price of $20.00 in the Stock
          Conversion. As the Converted Bank accrues compensation expense to
          reflect the vesting of such shares pursuant to the MRP, the charge
          against capital will be reduced accordingly. Implementation of the MRP
          within one year of the Stock Conversion would require stockholder
          approval at a meeting of our stockholders. If the shares to be
          purchased by the MRP were newly issued shares purchased from the
          Company by the MRP at the Purchase Price rather than shares purchased
          in the open market, at the minimum, midpoint, maximum and 15% above
          the maximum of the Estimated Valuation Range, pro forma stockholders'
          equity per share would have been $33.22, $31.06, $29.43 and $27.97,
          respectively, and pro forma net income per share would have been
          $2.08, $1.84, $1.66 and $1.50, respectively. If the MRP acquires
          authorized but unissued shares from the Company, your ownership
          interests in the Company would be diluted by approximately 4%. See
          "Management of the Bank -- Proposed Future Stock Benefit Plans --
          Management Recognition Plan" and "Risk Factors --Dilutive Effect of
          MRP and Stock Options."
(3)       Consolidated stockholders' equity represents the excess of the
          carrying value of our assets over our liabilities. The amounts shown
          do not reflect the federal income tax consequences of the potential
          restoration to income of the bad debt reserves for income tax
          purposes, which would be required in the event of liquidation or in
          certain other remote circumstances. The amounts shown also do not
          reflect the amounts required to be distributed in the event of
          liquidation to eligible depositors from the liquidation account which
          will be established upon the consummation of the Stock Conversion. Pro
          forma stockholders' equity information is not intended to represent
          the fair market value of the common stock, the current value of the
          Bank's assets or liabilities or the amounts, if any, that would be
          available for distribution to stockholders in the event of
          liquidation. Such pro forma data may be materially affected by a
          change in the number of shares to be sold in the Stock Conversion and
          by other factors.
(4)       No effect has been given to shares that may be issued upon the
          exercise of options that may be granted under a stock option plan. 

                                       15
COMPARISON OF VALUATION AND PRO FORMA INFORMATION WITH NO FOUNDATION

       Had we not established the Foundation as part of the Stock Conversion,
  Ferguson has estimated that our pro forma market capitalization would have
  been approximately $35.0 million, at the midpoint, which is approximately $2.0
  million greater than our pro forma market capitalization with the Foundation.
  This would result in approximately a $5.0 million increase in the amount of
  common stock that would be offered for sale in the Offering.  Further, at the
  midpoint of the Estimated Valuation Range, pro forma stockholders' equity per
  share and pro forma consolidated net income per share would be $31.51 and
  $1.90, respectively, with the Foundation, as compared to $31.84 and $1.86,
  respectively, without the Foundation.  At the midpoint of the Estimated
  Valuation Range, the pro forma price to book ratio and the pro forma price to
  earnings ratio are 63.5% and 10.5x, respectively, with the Foundation, as
  compared to 62.9% and 10.8x, respectively, without the Foundation.  The
  following table does not reflect the after-tax expense of $2.0 million we will
  incur during the year ending September 30, 1999 as a result of our
  contribution of 150,000 shares of common stock to the Foundation.

       For comparative purposes only, set forth below are certain pricing ratios
  and financial data and ratios, at the minimum, midpoint, maximum and maximum,
  as adjusted, of the Estimated Valuation Range, assuming the Stock Conversion
  was completed at September 30, 1998.
1,275,000 Shares at         1,500,000 Shares         1,725,000 Shares at       1,983,750 Shares at 
                                 $20.00 Per Share          $20.00 Per Share          $20.00 Per Share          $20.00 Per Share  
                             -----------------------   -----------------------   -----------------------   ----------------------- 
                                With          No          With          No          With          No          With          No
                             Foundation   Foundation   Foundation   Foundation   Foundation   Foundation   Foundation   Foundation
                             ----------   ----------   ----------   ----------   -----------  ----------   -----------  ----------
                                                         (Dollars in thousands, except per share data)
Estimated gross offering
   amount..................    $ 25,500     $ 29,750     $ 30,000     $ 35,000     $ 34,500     $ 40,250     $ 39,675     $ 46,288
  Pro forma market
   capitalization..........      28,500       29,750       33,000       35,000       37,500       40,250       42,675       46,288
  Total assets.............     309,325      313,363      313,223      317,911      317,121      322,458      321,604      327,689
  Total liabilities........     262,258      262,258      262,258      262,258      262,258      262,258      262,258      262,258
  Pro forma stockholders'
   equity..................      48,088       51,106       51,986       55,654       55,884       60,201       60,367       65,432
  Pro forma consolidated
   net earnings............       2,837        2,940        2,903        3,018        2,969        3,095        3,046        3,184
  Pro forma stockholders'
   equity per share........       33.75        34.36        31.51        31.80        29.80        29.91        28.29        28.27
  Pro forma consolidated
   net income
    per share..............        2.15         2.13         1.90         1.86         1.71         1.66         1.54         1.48
 
  Pro forma pricing ratios:
     Offering price as a
      percentage of pro
       forma stockholders'
        equity per share...        59.3%        58.2%        63.5%        62.9%        67.1%        66.9%        70.7%        70.7%
     Offering price to pro
      forma net earnings
          per share........         9.3x         9.4x        10.5x        10.8x        11.7x        12.0x        13.0x        13.5x
     Offering price to
      assets per share.....         9.2%         9.5%        10.5%        11.0%        11.8%        12.5%        13.3%        14.1%
 
  Pro forma financial
   ratios:
      Return on assets.....        0.96%        0.99%        0.97%        1.00%        0.98%        1.01%        0.99%        1.02%
      Return on
       stockholders' equity        6.07%        5.91%        5.73%        5.56%        5.44%        5.26%        5.16%        4.97%
      Stockholders' equity
       to assets...........        15.5%        16.3%        16.6%        17.5%        17.6%        18.7%        18.8%        20.0%
16
THE CONVERSION

       OUR BOARD OF DIRECTORS AND THE ADMINISTRATOR HAVE APPROVED THE PLAN,
  SUBJECT TO THE PLAN'S APPROVAL BY OUR MEMBERS ENTITLED TO VOTE ON THE MATTER
  AND SUBJECT TO THE SATISFACTION OF CERTAIN OTHER CONDITIONS.  SUCH APPROVAL BY
  THE ADMINISTRATOR, HOWEVER, DOES NOT CONSTITUTE A RECOMMENDATION OR
  ENDORSEMENT OF THE PLAN.

  GENERAL

       On August 11, 1998, our Board of Directors unanimously adopted, subject
  to approval by the Administrator and our members, and to the nonobjection by
  the FDIC, the Plan, pursuant to which we would implement the Conversion.  The
  Administrator has approved the Plan subject to, among other things, approval
  of the Plan by our members.  In addition, the FDIC has issued its conditional
  non-objection to the Plan and the Stock Conversion.  A Special Meeting of our
  members has been called for the purpose of approving the Plan, which meeting
  is to be held on ___________, 1999.

       The Stock Conversion will be accomplished through the amendment of the
  Bank's existing North Carolina mutual Articles of Incorporation and Bylaws to
  read in the form of North Carolina stock Articles of Incorporation and Bylaws
  to authorize the issuance of capital stock by the Converted Bank, the issuance
  of all the Converted Bank's capital stock to be outstanding upon consummation
  of the Stock Conversion to the Company and the offer and sale of the common
  stock of the Company.  Upon issuance of the Converted Bank's shares of capital
  stock to the Company, the Converted Bank will be a wholly owned subsidiary of
  the Company.  Immediately following consummation of the Stock Conversion, the
  Board of Directors of the Bank intends to complete the Bank Conversion.  Upon
  completion of the Bank Conversion, the Converted Bank will remain a wholly
  owned subsidiary of the Company.

       The Stock Conversion will be effected only upon completion of the sale of
  all of the shares of common stock to be issued by the Company pursuant to the
  Plan.  The Bank has received approval from the Administrator and the
  Commission, subject to certain conditions, of the conversion of the Converted
  Bank to a North Carolina commercial bank, and the Company has applied to the
  Federal Reserve Board for approval of the Company's continued ownership of
  100% of the stock of the Converted Bank following the Bank Conversion.

       Under the Plan, the Company is offering shares of the common stock first
  to our Eligible Account Holders, second to the ESOP, third to Supplemental
  Eligible Account Holders and fourth to our Other Members who are not Eligible
  Account Holders or Supplemental Eligible Account Holders in the Subscription
  Offering.  Subscription rights received in any of the foregoing categories
  will be subordinated to the subscription rights received by those in a prior
  category.  To the extent shares remain available for purchase after the
  Subscription Offering, the Company may offer any such remaining shares to the
  general public in the Community Offering.  In the Community Offering, we will
  give preference to natural persons and trusts of natural persons who are
  permanent residents of Alamance County, North Carolina. We reserve the right
  to reject any such orders, in whole or in part in the Community Offering.

       As part of the Community Offering, the Plan provides that, if feasible,
  all shares of common stock not purchased in the Subscription and Community
  Offerings, if any, may be offered for sale to the general public in a
  Syndicated Community Offering through a syndicate of selected dealers to be
  formed and managed by Trident Securities.

       The following is a brief summary of material aspects of the Conversion.
  The summary is qualified in its entirety by reference to the provisions of the
  Plan.  A copy of the Plan is available for inspection at any office of the
  Bank and at the office of the Administrator.  The Plan is also filed as an
  exhibit to the Registration Statement of which this Prospectus is a part.
  Copies of the Registration Statement may be obtained from the SEC.  See
  "Additional Information."

                                       17
BUSINESS PURPOSES

       Our Board of Directors has formed 1st State Bancorp, Inc. to serve upon
  consummation of the Conversion as a holding company for the Converted Bank.
  The portion of the net proceeds from the sale of the common stock in the
  Offering to be distributed to the Converted Bank by the Company will
  substantially increase the Converted Bank's capital position which will in
  turn increase the amount of funds available for lending and investment and
  provide greater resources to support both current operations and future
  expansion by the Converted Bank.  We have no current agreements or
  understandings for such expansion.  The holding company structure will provide
  greater flexibility than the Bank alone would have for diversification of
  business activities and geographic expansion.  We believe that this increased
  capital and operating flexibility will enable the Converted Bank to compete
  more effectively with other types of financial services organizations.  In
  addition, the Conversion will also enhance our future access to the capital
  markets.

       Our Board of Directors determined that operating as a commercial bank
  will allow us to continue to pursue our expanding lines of business.  We
  intend to emphasize commercial real estate loans, commercial loans and
  consumer loans.  See "Risk Factors --  Risks Related to Commercial and
  Consumer Lending" and "Management's Discussion and Analysis of Financial
  Condition and Results of Operations -- General."  We believe this strategy can
  be more effectively developed by operating under regulatory requirements
  applicable to a North Carolina commercial bank rather than a North Carolina-
  chartered savings bank.  See "Regulation -- Depository Institution
  Regulation."

       After completion of the Stock Conversion, the unissued common stock and
  preferred stock authorized by our Articles of Incorporation will permit us,
  subject to market conditions, to raise additional equity capital through
  further sales of securities and to issue securities in connection with
  possible acquisitions.  At the present time, we do not have any plans with
  respect to additional offerings of securities, other than the issuance of
  additional shares under a restricted stock plan or a stock option plan, if
  implemented.  Following completion of the Stock Conversion, we also will be
  able to use stock-related incentive programs to attract and retain executive
  and other personnel.  See "Management of the Bank --Future Proposed Stock
  Benefit Plans."

  EFFECT OF CONVERSION TO STOCK FORM ON DEPOSITORS AND BORROWERS OF THE BANK

       General.  Each depositor in a mutual savings institution such as the Bank
  has both a deposit account and a pro rata ownership interest in the retained
  earnings of that institution based upon the balance in his or her deposit
  account.  However, this ownership interest is tied to the depositor's account
  and has no tangible market value separate from such deposit account.  Any
  other depositor who opens a deposit account obtains a pro rata interest in the
  retained earnings of the institution without any additional payment beyond the
  amount of the deposit.  A depositor who reduces or closes his or her account
  receives a portion or all of the balance in the account but nothing for his or
  her ownership interest, which is lost to the extent that the balance in the
  account is reduced.

       Consequently, depositors normally do not have a way to realize the value
  of their ownership, which has realizable value only in the unlikely event that
  the mutual institution is liquidated.  In such event, the depositors of record
  at that time, as owners, would share pro rata in any residual retained
  earnings after other claims are paid.

       Upon consummation of the Stock Conversion, permanent nonwithdrawable
  capital stock will be created to represent the ownership of the institution.
  The stock is separate and apart from deposit accounts and is not and cannot be
  insured by the FDIC.  Transferable certificates will be issued to evidence
  ownership of the stock, which will enable the stock to be sold or traded, if a
  purchaser is available, with no effect on any account held in the Bank.  Under
  the Plan, all of the capital stock of the Converted Bank will be acquired by
  the Company in exchange for a portion of the net proceeds from the sale of the
  common stock in the Stock Conversion.  The common stock will represent an
  ownership interest in the Company and will be issued upon consummation of the
  Stock Conversion to persons who elect to participate in the Stock Conversion
  by purchasing the shares being offered.

                                       18
Continuity.  During the Conversion process, our normal business of
  accepting deposits and making loans will continue without interruption.  The
  Converted Bank will continue to be subject to regulation by the Administrator
  and the FDIC, and will be subject to regulation by the Commissioner and the
  FDIC following the Bank Conversion, and FDIC insurance of accounts will
  continue without interruption. After the Conversion, the Converted Bank will
  continue to provide services for depositors and borrowers under current
  policies and by present management and staff.

       The Board of Directors serving the Bank at the time of the Conversion
  will serve as the Board of Directors of the Converted Bank after the
  Conversion.  The Board of Directors of the Company will consist of the
  individuals currently serving on the Board of Directors of the Bank.  All of
  our officers at the time of the Conversion will retain their positions with
  the Converted Bank after the Conversion.

       Voting Rights.  Upon the completion of the Conversion, depositor and
  borrower members as such will have no voting rights in the Converted Bank or
  the Company and, therefore, will not be able to elect directors of the
  Converted Bank or the Company or to control their affairs.  Currently these
  rights are accorded to our depositors.  Subsequent to the Stock Conversion,
  voting rights will be vested exclusively in the stockholders of the Company.
  Each holder of common stock shall be entitled to vote on any matter to be
  considered by the stockholders of the Company, subject to the provisions of
  the Company's Articles of Incorporation.

       Deposit Accounts and Loans. OUR DEPOSIT ACCOUNTS, THE BALANCES OF
  INDIVIDUAL ACCOUNTS AND EXISTING FEDERAL DEPOSIT INSURANCE COVERAGE WILL NOT
  BE AFFECTED BY THE CONVERSION. Furthermore, the Conversion will not affect the
  loan accounts, the balances of these accounts and the obligations of the
  borrowers under their individual contractual arrangements with us.

       Tax Effects.  We have received an opinion from our special counsel,
  Housley Kantarian & Bronstein, P.C., Washington, D.C., as to the material
  federal income tax consequences of the Conversion to the Bank and the
  Converted Bank, and as to the generally applicable material federal income tax
  consequences of the Conversion to our account holders and to persons who
  purchase common stock in the Stock Conversion.  The opinion provides that the
  Conversion will constitute one or more reorganizations for federal income tax
  purposes under Section 368(a)(1)(F) of the Internal Revenue Code.  Among other
  things, the opinion also provides that: (i) no gain or loss will be recognized
  by us in our mutual or stock form by reason of the Stock Conversion; (ii) no
  gain or loss will be recognized by our account holders upon the issuance to
  them of accounts in the Converted Bank in stock form immediately after the
  Stock Conversion, in the same dollar amounts and on the same terms and
  conditions as their accounts with us immediately prior to the Stock
  Conversion; (iii) the tax basis of each account holder's interest in the
  liquidation account will be equal to the value, if any, of that interest; (iv)
  the tax basis of the common stock purchased in the Stock Conversion will be
  equal to the amount paid therefor increased, in the case of common stock
  acquired pursuant to the exercise of subscription rights, by the fair market
  value, if any, of the subscription rights exercised; (v) the holding period
  for the common stock purchased in the Stock Conversion will commence upon the
  exercise of such holder's subscription rights and otherwise on the day
  following the date of such purchase; (vi) gain or loss will be recognized to
  account holders upon the receipt of liquidation rights or the receipt or
  exercise of subscription rights in the Stock Conversion, to the extent such
  liquidation rights and subscription rights are deemed to have value, as
  discussed below; and (vii) as a result of Public Law 104-188, we and our
  successors (including the Converted Bank) will be required to recapture the
  applicable excess reserves into gross income ratably over a six taxable year
  period. The applicable excess reserves are the excess, if any, of (1) the
  balance of our reserves as of the close of our last taxable year beginning
  before January 1, 1996, over (2) the greater of the balance of (a) our pre-
  1988 reserves, or (b) what our reserves would have been at the close of our
  last taxable year beginning before January 1, 1996, had we always used the
  experience method (the six-year average method).

       The opinion of Housley Kantarian & Bronstein, P.C. is based in part upon,
  and subject to the continuing validity in all material respects through the
  date of the Conversion of, our various representations and upon certain
  assumptions and qualifications, including that the Conversion is consummated
  in the manner and according to the terms provided in the Plan.  Such opinion
  is also based upon the Internal Revenue Code, regulations now in effect or
  proposed

                                       19
thereunder, current administrative rulings and practice and judicial
  authority, all of which are subject to change and such change may be made with
  retroactive effect. Unlike private letter rulings received from the IRS, an
  opinion is not binding upon the IRS and there can be no assurance that the IRS
  will not take a position contrary to the positions reflected in such opinion,
  or that such opinion will be upheld by the courts if challenged by the IRS.

       Housley Kantarian & Bronstein, P.C. has advised us that an interest in a
  liquidation account has been treated by the IRS, in a series of private letter
  rulings which do not constitute formal precedent, as having nominal, if any,
  fair market value and therefore it is likely that the interests in the
  liquidation account established by us as part of the Stock Conversion will
  similarly be treated as having nominal, if any, fair market value.
  Accordingly, it is likely that our  depositors who receive an interest in such
  liquidation account established by us pursuant to the Stock Conversion will
  not recognize any gain or loss upon such receipt.

       Housley Kantarian & Bronstein, P.C. has further advised us that the
  federal income tax treatment of the receipt of subscription rights pursuant to
  the Stock Conversion is uncertain, and recent private letter rulings issued by
  the IRS have been in conflict.  For instance, the IRS adopted the position in
  one private ruling that subscription rights will be deemed to have been
  received to the extent of the minimum pro rata distribution of such rights,
  together with the rights actually exercised in excess of such pro rata
  distribution, and with gain recognized to the extent of the combined fair
  market value of the pro rata distribution of subscription rights plus the
  subscription rights actually exercised.  Persons who do not exercise their
  subscription rights under this analysis would recognize gain upon receipt of
  rights equal to the fair market value of such rights, regardless of exercise,
  and would recognize a corresponding loss upon the expiration of unexercised
  rights that may be available to offset the previously recognized gain.  Under
  another IRS private ruling, subscription rights were deemed to have been
  received only to the extent actually exercised.  This private ruling required
  that gain be recognized only if the holder of such rights exercised such
  rights, and that no loss be recognized if such rights were allowed to expire
  unexercised.  There is no authority that clearly resolves this conflict among
  these private rulings, which may not be relied upon for precedential effect.
  However, based upon express provisions of the Internal Revenue Code and in the
  absence of contrary authoritative guidance, Housley Kantarian & Bronstein,
  P.C. has provided in its opinion that gain will be recognized upon the receipt
  rather than the exercise of subscription rights.  Further, also based upon a
  published IRS ruling and consistent with recognition of gain upon receipt
  rather than exercise of the subscription rights, Housley Kantarian &
  Bronstein, P.C. has provided in its opinion that the subsequent exercise of
  the subscription rights will not give rise to gain or loss.  Regardless of the
  position eventually adopted by the IRS, the tax consequences of the receipt of
  the subscription rights will depend, in part, upon their valuation for federal
  income tax purposes.

       If the subscription rights are deemed to have a fair market value, the
  receipt of such rights will be taxable to you if you exercise your
  subscription rights, even though you would have received no cash from which to
  pay taxes on such taxable income.  We could also recognize a gain on the
  distribution of such subscription rights in an amount equal to their aggregate
  value.  In the opinion of Ferguson, whose opinion is not binding upon the IRS,
  the subscription rights do not have any value, based on the fact that such
  rights are acquired by the recipients without cost, are non-transferable and
  of short duration and afford the recipients the right only to purchase shares
  of the common stock at a price equal to its estimated fair market value, which
  will be the same price as the price paid by purchasers in the Community
  Offering for unsubscribed shares of common stock.  We encourage you to consult
  with your own tax advisors as to the tax consequences in the event that the
  subscription rights are deemed to have a fair market value.  Because the fair
  market value, if any, of the subscription rights issued in the Stock
  Conversion depends primarily upon the existence of certain facts rather than
  the resolution of legal issues, Housley Kantarian & Bronstein, P.C., has
  neither adopted the opinion of Ferguson as its own nor incorporated such
  opinion in its opinion issued in connection with Conversion.

       We have also obtained an opinion from KPMG Peat Marwick LLP to the effect
  that the tax effects of the Conversion under North Carolina tax laws will be
  substantially the same as described above with respect to federal income tax
  laws.

                                       20
THE FEDERAL AND STATE INCOME TAX DISCUSSION SET FORTH ABOVE DOES NOT
  PURPORT TO CONSIDER ALL ASPECTS OF FEDERAL AND STATE INCOME TAXATION WHICH MAY
  BE RELEVANT TO EACH ELIGIBLE ACCOUNT HOLDER, SUPPLEMENTAL ELIGIBLE ACCOUNT
  HOLDER AND OTHER MEMBER ENTITLED TO SPECIAL TREATMENT UNDER THE INTERNAL
  REVENUE CODE, SUCH AS TRUSTS, INDIVIDUAL RETIREMENT ACCOUNTS, OTHER EMPLOYEE
  BENEFIT PLANS, INSURANCE COMPANIES AND ELIGIBLE ACCOUNT HOLDERS, SUPPLEMENTAL
  ELIGIBLE ACCOUNT HOLDERS AND OTHER MEMBERS WHO ARE NOT CITIZENS OR RESIDENTS
  OF THE UNITED STATES.  DUE TO THE INDIVIDUAL NATURE OF TAX CONSEQUENCES, YOU
  ARE URGED TO CONSULT YOUR OWN TAX AND FINANCIAL ADVISOR AS TO THE EFFECT OF
  SUCH FEDERAL AND STATE INCOME TAX CONSEQUENCES ON YOUR OWN PARTICULAR FACTS
  AND CIRCUMSTANCES, INCLUDING THE RECEIPT AND EXERCISE OF SUBSCRIPTION RIGHTS,
  AND ALSO AS TO ANY OTHER TAX CONSEQUENCES ARISING OUT OF THE CONVERSION.

       Liquidation Account.  In the unlikely event of our complete liquidation
  in our present mutual form, each holder of a deposit account in the Bank would
  receive his pro rata share of any of our assets remaining after payment of
  claims of all creditors (including the claims of all depositors to the
  withdrawal value of their accounts).  His pro rata share of such remaining
  assets would be the same proportion of such assets as the value of his deposit
  account was to the total of the value of all deposit accounts in the Bank at
  the time of liquidation.

       After the Stock Conversion, each deposit account holder on a complete
  liquidation would have a claim of the same general priority as the claims of
  all other general creditors of the Bank.  Therefore, except as described
  below, his claim would be solely in the amount of the balance in his deposit
  account plus accrued interest.  He would have no interest in the value of the
  Bank above that amount.

       The Plan provides for the establishment, upon the completion of the Stock
  Conversion, of a special "liquidation account" for the benefit of Eligible
  Account Holders and Supplemental Eligible Account Holders in an amount equal
  to our net worth as of the date of our latest statement of financial condition
  contained in the prospectus to be used in connection with the Stock
  Conversion.  Each Eligible Account Holder (a person with a deposit account in
  the Bank on December 31, 1994) and each Supplemental Eligible Account Holder
  (a person with a qualifying deposit in the Bank on December 31, 1998) would be
  entitled, on a complete liquidation of the Converted Bank after completion of
  the Stock Conversion, to an interest in the liquidation account.  Each
  Eligible Account Holder would have an initial interest in such liquidation
  account for each deposit account held in the Bank on December 31, 1994 and
  each Supplemental Eligible Account Holder would have an initial interest in
  such liquidation account for each qualifying deposit held in the Bank on
  December 31, 1998.  The interest as to each qualifying deposit account would
  be in the same proportion of the total liquidation account as the balance of
  such qualifying deposit account was to the balance in all deposit accounts of
  Eligible Account Holders and Supplemental Eligible Account Holders on such
  date.  However, if the amount in the qualifying deposit account on any annual
  closing date (September 30) of the Bank subsequent to the relevant eligibility
  date is less than the amount in such account on the relevant eligibility date,
  or any subsequent closing date, then the Eligible Account Holder's or
  Supplemental Eligible Account Holder's interest in the liquidation account
  would be reduced from time to time by an amount proportionate to any such
  reductions, and such interest would cease to exist if he ceases to maintain an
  account at the Converted Bank that has the same Social Security number as
  appeared on his account(s) at the relevant eligibility date.  The interest in
  the liquidation account would never be increased, notwithstanding any increase
  in the related deposit account after the Stock Conversion.

       Any assets remaining after the above liquidation rights of Eligible
  Account Holders and Supplemental Eligible Account Holders were satisfied would
  be distributed to stockholders at that time.

       The Bank Conversion shall not be deemed to be a complete liquidation of
  the Converted Bank for purposes of the distribution of the liquidation
  account.  Upon consummation of the Bank Conversion, the liquidation account,
  and all rights and obligations of the Converted Bank in connection therewith,
  shall be continued.

       A merger, consolidation, sale of bulk assets or similar combination or
  transaction with an FDIC-insured institution in which we are not the surviving
  insured institution would not be considered to be a "liquidation" under

                                       21
which distribution of the liquidation account could be made. In such a
  transaction, the liquidation account would be assumed by the surviving
  institution.

       The creation and maintenance of the liquidation account will not restrict
  the use or application of any of our capital accounts, except that we may not
  declare or pay a cash dividend on, or repurchase any of, our capital stock if
  the effect of such dividend or repurchase would be to cause our retained
  earnings to be reduced below the aggregate amount then required for the
  liquidation account.

  SUBSCRIPTION RIGHTS

       Nontransferable subscription rights to subscribe for shares of the common
  stock have been issued to all persons entitled to subscribe for stock in the
  Subscription Offering at no cost to such persons.  The amount of the common
  stock which these parties may subscribe for will be determined, in part, by
  the total stock to be issued and the availability of stock for purchase under
  the categories set forth in the Plan.

            Preference categories have been established for the allocation of
       the common stock to the extent that shares are available. These
       categories, in order of preference, are as follows:

            Subscription Category No. 1 is reserved for the Bank's Eligible
       Account Holders, i.e., qualifying depositors of the Bank on December 31,
       1994, who, including individuals on a joint account or having the same
       address of the Bank's records, will each receive nontransferable
       subscription rights to subscribe for common stock in the Subscription
       Offering up to $1,000,000. See "-- Limitations on Purchase of Shares." If
       the exercise of subscription rights in this category results in an over-
       subscription, shares shall be allocated among subscribing Eligible
       Account Holders so as to permit each such Eligible Account Holder, to the
       extent possible, to purchase a number of shares sufficient to make his
       total allocation equal 100 shares or the amount subscribed for, whichever
       is less. Any shares not so allocated shall be allocated among the
       subscribing Eligible Account Holders on an equitable basis related to the
       amounts of their respective qualifying deposits, as compared to the total
       qualifying deposits of all subscribing Eligible Account Holders. TO
       ENSURE A PROPER ALLOCATION OF COMMON STOCK, EACH ELIGIBLE ACCOUNT HOLDER
       MUST LIST ON HIS STOCK ORDER FORM ALL ACCOUNTS IN WHICH HE HAS AN
       OWNERSHIP INTEREST. FAILURE TO LIST ALL SUCH DEPOSIT ACCOUNTS MAY CAUSE
       US TO BE UNABLE TO FILL ALL OR PART OF A SUBSCRIPTION ORDER. NEITHER THE
       COMPANY, THE BANK NOR ANY OF THEIR AGENTS SHALL BE RESPONSIBLE FOR ORDERS
       ON WHICH ALL DEPOSIT ACCOUNTS HAVE NOT BEEN FULLY AND ACCURATELY
       DISCLOSED. Subscription rights received by directors and officers of the
       Bank and their associates in this category based on their increased
       deposits in the Bank in the one-year period preceding December 31, 1994
       are subordinated to the subscription rights of other Eligible Account
       Holders.

            Subscription Category No. 2 is reserved for the Bank's tax-qualified
       employee stock benefit plans, i.e., the ESOP, which shall receive
       nontransferable subscription rights to purchase in the aggregate up to
       10% of the shares issued in the Stock Conversion and which is expected to
       purchase 8% of the common stock offered in the Stock Conversion. If all
       the shares of common stock offered in the Subscription Offering are
       purchased by Eligible Account Holders, then the ESOP will purchase shares
       in the open market following consummation of the Stock Conversion and
       will not purchase newly issued shares from the Company.

            Subscription Category No. 3 is reserved for the Bank's Supplemental
       Eligible Account Holders, i.e., qualifying depositors of the Bank on the
       last day of the calendar quarter preceding the Administrator's approval
       of the Plan (December 31, 1998) who, including individuals on a joint
       account or having the same address on the Bank's records, will each
       receive nontransferable subscription rights to subscribe for common stock
       in the Subscription Offering up to $1,000,000. See "-- Limitations on
       Purchase of Shares." If the exercise of subscription rights in this
       category results in an oversubscription, shares shall be allocated among
       subscribing Supplemental Eligible Account Holders, so as to permit each
       such Supplemental Eligible Account Holder, to the extent possible, to
       purchase a number of shares sufficient to make his total allocation equal
       100 shares or

                                       22
the amount subscribed for, whichever is less, and any shares not so
       allocated shall be allocated among the subscribing Supplemental Eligible
       Account Holders on an equitable basis related to the amounts of their
       respective qualifying deposits, as compared to the total qualifying
       deposits of all subscribing Supplemental Eligible Account Holders. TO
       ENSURE A PROPER ALLOCATION OF COMMON STOCK, EACH SUPPLEMENTAL ELIGIBLE
       ACCOUNT HOLDER MUST LIST ON HIS STOCK ORDER FORM ALL ACCOUNTS IN WHICH HE
       HAS AN OWNERSHIP INTEREST. FAILURE TO LIST ALL SUCH DEPOSIT ACCOUNTS MAY
       CAUSE US TO BE UNABLE TO FILL ALL OR PART OF A SUBSCRIPTION ORDER.
       NEITHER THE COMPANY, THE BANK NOR ANY OF THEIR AGENTS SHALL BE
       RESPONSIBLE FOR ORDERS ON WHICH ALL DEPOSIT ACCOUNTS HAVE NOT BEEN FULLY
       AND ACCURATELY DISCLOSED. Subscriptions in this Category No. 3 will be
       filled only to the extent that there are sufficient shares of common
       stock remaining after satisfaction of subscriptions by Category Nos. 1
       and 2.

           Subscription Category No. 4 is reserved for Other Members, i.e.,
       certain depositors and borrowers who are members of the Bank as of the
       Voting Record Date entitled to vote at the Special Meeting but who are
       not Eligible Account Holders or Supplemental Eligible Account Holders. To
       the extent then available following subscriptions by Eligible Account
       Holders, tax-qualified employee stock benefit plans and Supplemental
       Eligible Account Holders, Other Members, including individuals on a joint
       account or having the same address of the Bank's records, will receive,
       without payment therefor, nontransferable subscription rights to
       subscribe for common stock in the Subscription Offering up to $1,000,000.
       See "-- Limitations on Purchase of Shares." In the event that Other
       Members subscribe for a number of shares which, when added to the shares
       subscribed for by Eligible Account Holders, tax-qualified employee stock
       benefit plans and Supplemental Eligible Account Holders, is in excess of
       the total number of shares offered in the Stock Conversion, the
       subscriptions of such Other Members will be allocated pro rata among
       subscribing Other Members on an equitable basis as determined by the
       Board of Directors.

       We will make reasonable efforts to comply with the securities laws of all
  states in the United States in which persons entitled to subscribe for the
  common stock pursuant to the Plan reside. However, you will not be offered or
  allowed to purchase any common stock under the Plan if you reside in a foreign
  country or in a state of the United States with respect to which any or all of
  the following apply: (i) a small number of persons otherwise eligible to
  subscribe for shares under the Plan reside in such state or foreign country;
  (ii) the granting of subscription rights or the offer or sale of shares of
  common stock to you would require us or our employees to register, under the
  securities laws of such state, as a broker, dealer, salesman or agent or to
  register or otherwise qualify our securities for sale in such state or foreign
  country; and (iii) such registration or qualification would be impracticable
  for reasons of cost or otherwise. No payments will be made in lieu of the
  granting of subscription rights to you in such case.

  COMMUNITY OFFERING

       To the extent shares remain available for purchase after the Subscription
  Offering, we may offer any such remaining shares of the common stock to
  members of the general public to whom we deliver a copy of this Prospectus and
  a stock order form in the Community Offering. The Community Offering will not
  occur if shares of common stock are not available for purchase after
  satisfaction of all orders received in the Subscription Offering. The
  Community Offering, if one is held, will begin immediately after the
  Expiration Date, but may begin at any time during the Subscription Offering.
  The Community Offering may terminate without notice on or after the Expiration
  Date, but not later _____________, 1999 (or __________, 1999 if the
  Subscription Offering is fully extended), unless further extended with the
  consent of the FDIC and the Administrator. WE HAVE THE ABSOLUTE RIGHT TO
  ACCEPT OR REJECT ANY PURCHASES IN WHOLE OR IN PART IN THE COMMUNITY OFFERING
  IN OUR SOLE DISCRETION. WE PRESENTLY INTEND TO TERMINATE THE COMMUNITY
  OFFERING, IF ANY, AS SOON AS WE HAVE RECEIVED ORDERS FOR ALL SHARES AVAILABLE
  FOR PURCHASE IN THE STOCK CONVERSION.

       In the event an insufficient number of shares are available to fill
  orders in the Community Offering, we will allocate the available shares in our
  discretion so that a preference shall be given to natural persons and trusts
  of natural persons who are permanent residents of Alamance County, North
  Carolina. The term "resident" as used in relation to

                                       23
the preference afforded natural persons in Alamance County means any natural
  person who occupies a dwelling within Alamance County, has an intention to
  remain within Alamance County for a period of time (manifested by establishing
  a physical, ongoing, nontransitory presence within Alamance County) and
  continues to reside in Alamance County at the time of the Subscription and
  Community Offerings. We may utilize deposit or loan records or such other
  evidence provided to us to make the determination whether a person is residing
  in Alamance County. To the extent the person is a corporation or other
  business entity, the principal place of business or headquarters shall be
  within Alamance County. To the extent the person is a personal benefit plan,
  the circumstances of the beneficiary shall apply with respect to this
  definition. In the case of all other benefit plans, circumstances of the
  beneficiary shall be examined for purposes of this definition. In all cases,
  however, such determination shall be in our sole discretion.

       If the Community Offering extends beyond 45 days following the expiration
  of the Subscription Offering, sub  scribers will have the right to increase,
  decrease or rescind subscriptions for stock previously submitted.  Purchasers
  in the Community Offering, together with their associates and groups acting in
  concert, including individuals on joint accounts or having the same address on
  the Bank's records, are each eligible to purchase up to $1,000,000 of the
  common stock issued in the Offering.

       Except as noted below, cash and checks received in the Community Offering
  will be placed in a segregated savings account (insured by the FDIC up to the
  applicable $100,000 limit) established specifically for this purpose.
  Interest will be paid on orders made by check, in cash or by money order at
  the Bank's passbook rate from the date we receive the payment until the
  consummation of the Stock Conversion.  In the event that the Stock Conversion
  is not consummated for any reason, all funds submitted pursuant to the
  Community Offering will be promptly refunded with interest as described above.

       If the Community Offering is determined not to be feasible, we will
  immediately consult with the regulatory authorities to determine the most
  viable alternative available to effect the completion of the Stock Conversion.
  Should no viable alternative exist, we may terminate the Stock Conversion with
  the concurrence of the FDIC and the Administrator.  The Plan provides that the
  Stock Conversion must be completed within 12 months after approval of the Plan
  at the Special Meeting, which time period may be extended up to an additional
  12 months by amendment to the Plan.  In the event that the Stock Conversion is
  not effected, we will remain a North Carolina-chartered mutual savings bank,
  all subscription funds will be promptly returned to subscribers with interest
  earned thereon and all withdrawal authorizations will be canceled.  The
  completion of the Subscription and Community Offerings are subject to market
  conditions and other factors beyond our control.  No assurance can be given as
  to the length of time after approval of the Plan at the Special Meeting that
  will be required to complete the sale of the common stock to be offered in the
  Stock Conversion.  If delays are experienced, significant changes may occur in
  our estimated pro forma market value, together with corresponding changes in
  the offering price and the net proceeds realized from the sale of the common
  stock.  We would also incur substantial additional printing, legal and
  accounting expenses in completing the Stock Conversion.  In the event the
  Stock Conversion is terminated, we would be required to charge all Stock
  Conversion expenses against current income.

  SYNDICATED COMMUNITY OFFERING

       As part of the Community Offering, all shares of common stock not
  purchased in the Subscription and Community Offerings, if any, may be offered
  for sale to the general public in a Syndicated Community Offering through
  selected dealers to be formed and managed by Trident Securities.  The
  Syndicated Community Offering, if any, will be conducted to achieve the widest
  distribution of common stock subject to our right to reject orders in whole or
  in part in our sole discretion.  Neither Trident Securities nor any registered
  broker-dealer shall have any obligation to take or purchase any shares of the
  common stock in the Syndicated Community Offering.  Common stock sold in the
  Syndicated Community Offering will be sold at the same price as in the
  Subscription and Community Offerings.

       During the Syndicated Community Offering, selected dealers may only
  solicit indications of interest from their customers to place orders with the
  Company as of a certain date ("Order Date") for the purchase of shares of
  common

                                       24
stock. When and if Trident Securities and the Company believe that enough
  indications and orders have been received in the Offerings to consummate the
  Stock Conversion, Trident Securities will request, as of the Order Date,
  selected dealers to submit orders to purchase shares for which they have
  received indications of interest from their customers. Selected dealers will
  send confirmations of the orders to such customers on the next business day
  after the Order Date. Selected dealers may debit the accounts of their
  customers on a date which will be three business days from the Order Date
  ("Settlement Date"). Customers who authorize selected dealers to debit their
  brokerage accounts are required to have the funds for payment in their account
  on but not before the Settlement Date. On the Settlement Date, selected
  dealers will remit funds to the account that the Company established for each
  selected dealer. After payment has been received by us from selected dealers,
  funds will earn interest at our passbook savings rate until the consummation
  of the Stock Conversion. In the event the Stock Conversion is not consummated
  as described above, funds with interest will be returned promptly to the
  selected dealers, who, in turn, will promptly credit its customers' brokerage
  account.

       The Syndicated Community Offering, if any, will terminate no more than 45
  days following the completion of the Subscription Offering, unless extended
  with the approval of the Administrator.  In the event the Community Offering
  is extended beyond 45 days following the expiration of this Subscription
  Offering, subscribers will have the right to increase, decrease or rescind
  subscriptions for stock previously submitted.  The Syndicated Community
  Offering may run concurrently with the Subscription and Community Offerings or
  subsequent to such offerings.

  ESTABLISHMENT OF THE FOUNDATION

       General.  Pursuant to the Plan, we will establish a charitable
  foundation, 1st State Bank Foundation, Inc., in connection with the Stock
  Conversion.  The Foundation will be dedicated to charitable and educational
  purposes within our market area.  We will contribute up to 150,000 shares of
  common stock to fund the Foundation.  The contribution of common stock to the
  Foundation will dilute the interests of stockholders and will materially
  reduce our earnings during the fiscal year ending September 30, 1999, the year
  in which the Foundation will be established.

       Purposes of the Foundation.   The purpose of the Foundation is to provide
  funding to support charitable causes and community development activities.  In
  recent years, we have emphasized community lending and development activities
  within the communities that we serve.  We are forming the Foundation as a
  complement to our existing community reinvestment act activities and not as a
  replacement for those activities.  While we intend to continue to emphasize
  community lending and development activities following the Conversion, such
  activities are not our sole corporate purpose.  The Foundation, conversely,
  will be completely dedicated to community activities and the promotion of
  charitable causes, and may be able to support such activities in ways that are
  not currently available to us. We believe that the Foundation will enable us
  to assist our local community in areas beyond community lending and
  development.  We believe the establishment of a charitable foundation is
  consistent with our commitment to community service.  We further believe that
  the funding of the Foundation with our common stock is a means of enabling the
  communities we serve to share in our growth and success long after the
  completion of the Conversion.  The Foundation will accomplish that goal by
  providing for continued ties between the Foundation and Bank, thereby forming
  a partnership with our community.  The establishment of the Foundation also
  will enable us to develop a unified charitable donation strategy and will
  centralize the responsibility for administration and allocation of corporate
  charitable funds.

       Structure of the Foundation. The Foundation will be incorporated under
  North Carolina law as a nonprofit corporation.  The Foundation's board of
  directors will be comprised of individuals who also serve as our directors or
  officers.  The members of the Foundation, who are comprised of its directors,
  will elect the directors at the annual meeting of the Foundation.  Directors
  will be elected annually.  Directors of the Foundation will not receive any
  additional compensation for serving as such.  The articles of incorporation of
  the Foundation provide that the Foundation is organized exclusively for
  charitable purposes, including community development, as set forth in Section
  501(c)(3) of the Internal Revenue Code.  The Foundation's articles of
  incorporation further provide that no part of the net earnings of the
  Foundation will inure to the benefit of, or be distributable to its directors,
  officers or members.  In addition, any person who is a director, officer or
  employee of the Bank, or has the power to direct its management or policies,
  or

                                       25
otherwise owes a fiduciary duty to the Bank (including the Company's
  directors), and will also serve as a director, officer or employee of the
  Foundation, is subject to conflicts of interest regulations.

       The authority for the affairs of the Foundation will be vested in the
  board of directors of the Foundation. The directors of the Foundation will be
  responsible for establishing the policies of the Foundation with respect to
  grants or donations by the Foundation, consistent with the purposes for which
  the Foundation was established.  Although no formal policy governing
  Foundation grants exists at this time, the Foundation's board of directors
  will adopt such a policy upon establishment of the Foundation.   As directors
  of a nonprofit corporation, directors of the Foundation will at all times be
  bound by their fiduciary duty to advance the Foundation's charitable goals, to
  protect the assets of the Foundation and to act in a manner consistent with
  the charitable purpose for which the Foundation is established.  As a
  condition to receiving the approval of the FDIC to the Conversion, the
  Foundation will be required to commit to the FDIC that all shares of common
  stock held by the Foundation will be voted in the same ratio as all other
  shares of common stock on all proposals considered by our stockholders;
  provided, however, that, consistent with such condition, the FDIC would waive
  this voting restriction under certain circumstances.  See " -- Tax
  Considerations."

       The Foundation's place of business will be located at our administrative
  offices, and initially the Foundation is expected to have no employees but
  will utilize our staff.  The board of directors of the Foundation will appoint
  such officers as may be necessary to manage the operations of the Foundation.
  In this regard, it is expected that the Bank will be required to provide the
  FDIC with a commitment that, to the extent applicable, the Bank will comply
  with the affiliate restrictions set forth in Sections 23A and 23B of the
  Federal Reserve Act with respect to any transactions between the Bank and the
  Foundation.

       The Foundation will receive working capital from any dividends that may
  be paid on the common stock in the future, and subject to applicable federal
  and state laws, loans collateralized by the common stock or from the proceeds
  of the sale of any of the common stock in the open market from time to time as
  may be permitted to provide the Foundation with additional liquidity.  As a
  private foundation under Section 501(c)(3) of the Code, the Foundation will be
  required to distribute annually in grants or donations, a minimum of 5% of the
  average fair market value of its net investment assets.

       Dilution of Stockholders' Interests.  We propose to contribute up to
  150,000 shares of common stock to the Foundation.  That number represents
  between 10.5% and 8.0% of the number of shares of common stock that will be
  outstanding following consummation of the Stock Conversion at the minimum and
  maximum, respectively, of the Estimated Valuation Range.  At the purchase
  price of $20.00 per share, the contribution to the Foundation will have a
  value of up to $3.0 million.  At the midpoint of the Estimated Valuation
  Range, upon completion of the Stock Conversion and establishment of the
  Foundation, the Company will have 1,650,000 shares of common stock issued and
  outstanding, of which the Foundation will own up to 150,000 shares, or 9.1%.
  As a result, your ownership and voting interests in the Company will be
  diluted.  See "Pro Forma Data."

       Impact on Earnings.  The contribution of common stock to the Foundation
  will have an adverse impact on our earnings in the year in which the
  contribution is made.  We will recognize the full expense in the amount of the
  contribution of common stock to the Foundation in the quarter in which it
  occurs, which is expected to be the quarter ending March 31 or June 30, 1999.
  The amount of the contribution will be up to $3.0 million.  The contribution
  expense will be partially offset by the tax benefit related to the expense.
  We anticipate that the contribution to the Foundation will be tax deductible,
  subject to an annual limitation based on 10% of annual taxable income.
  Assuming a contribution of $3.0 million in common stock, we estimate an after
  tax expense of $2.0 million (based on a 34% marginal federal tax rate).  If
  the Foundation had been established at September 30, 1998, we would have
  reported net income of $541,000 for the year ended September 30, 1998 rather
  than reporting net income of $2.5 million.  We cannot predict earnings for
  1999 but expect that the establishment and funding of the Foundation will
  materially reduce our earnings for that year.  However, in light of the
  expected contribution to the Foundation, we do not expect in the future to
  make other than nominal charitable contributions within the communities we
  serve.  In addition, we do not currently anticipate making additional
  contributions to the Foundation within the first five years following the
  initial contribution.

                                       26
Tax Considerations.  We anticipate that the Foundation will qualify as a
  Section 501(c)(3) exempt organization under the Internal Revenue Code and will
  be classified as a private foundation.  The Foundation will submit a request
  to the IRS to be recognized as an exempt organization.  Regulatory authorities
  require that common stock issued to the Foundation be voted in the same ratio
  as all other shares of our common stock on all proposals considered by our
  stockholders.  In the event that the Company or the Foundation receives an
  opinion of its legal counsel that compliance with the voting restriction would
  have the effect of causing the Foundation to lose its tax-exempt status, or
  otherwise have a material and adverse tax consequence on the Foundation, or
  subject the Foundation to an excise tax under Section 4941 of the Code, the
  FDIC and the Administrator shall waive such voting restriction upon submission
  of a legal opinion by the Company or the Foundation that is satisfactory to
  the FDIC and the Administrator.  We further anticipate that we will be
  entitled to a deduction in the amount of the fair market value of the stock at
  the time of the contribution, subject to an annual limitation based on 10% of
  annual taxable income.  However, we would be able to carry forward any unused
  portion of the deduction for five years following the contribution.  Thus,
  while we would receive a tax benefit of approximately $1.0 million in the year
  ending September 30, 1999, based upon a contribution of $3.0 million of common
  stock, we are permitted under the Internal Revenue Code to carry over the
  excess contribution in the five following years.  We estimate that for federal
  income tax purposes, a substantial portion of the deduction should be
  deductible over the six-year period. Although we anticipate that we will be
  entitled to the deduction of the charitable contribution, we cannot assure you
  that the IRS will recognize the Foundation as a Section 501(c)(3) exempt
  organization or that the deduction will be permitted. In such event, the tax
  benefit related to the Foundation would have to be fully expensed, resulting
  in further reduction in earnings in the year in which the IRS makes such a
  determination.

       Comparison of Valuation and Other Factors Assuming the Foundation is Not
  Established as Part of the Stock Conversion.  The establishment of the
  Foundation was taken into account by Ferguson in determining our estimated pro
  forma market value.  The number of shares of common stock being offered in the
  Offering and the Purchase Price are based upon the independent appraisal
  conducted by Ferguson of our estimated pro forma market value.  The Estimated
  Valuation Range is currently between $25.5 million and $34.5 million, with a
  midpoint of $30.0 million.  Ferguson has indicated that the establishment of
  the Foundation reduced the independent appraisal by $5.0 million at the
  midpoint of the Estimated Valuation Range, and that if we had not established
  the Foundation in connection with the Stock Conversion then the independent
  valuation would have been increased to a range of from $29.8 million to $40.3
  million with a midpoint of $35.0 million.  The pro forma price to book ratio
  and the pro forma price to annualized earnings ratio, at and for the year
  ended September 30, 1998, are 63.5% and 10.5x, respectively, at the midpoint
  of the Estimated Valuation Range.  In the event that the Stock Conversion did
  not include the Foundation,  Ferguson has estimated that the Independent
  Valuation would have been $35.0 million at the midpoint, which would have
  resulted in a pro forma price to book ratio and a pro forma price to earnings
  ratio of 62.9% and 10.8x, respectively.  See "Comparison of Valuation and Pro
  Forma Information with No Foundation."

       The decrease in the amount of common stock being offered as a result of
  the contribution of common stock to the Foundation will not have a significant
  effect on the Company's or the Bank's capital position.  The Bank's regulatory
  capital is significantly in excess of its regulatory capital requirements and
  will further exceed such requirements following the Stock Conversion.  The
  Bank's leverage and risk-based capital ratios at September 30, 1998 were 9.0%
  and 15.8%, respectively.  Assuming the sale of shares at the midpoint of the
  Estimated Valuation Range, the Bank's pro forma leverage and risk-based
  capital ratios at September 30, 1998 would be 13.0% and 22.3%, respectively.
  On a consolidated basis, our pro forma stockholders' equity would be $52.0
  million, or approximately 16.6% of pro forma consolidated assets, assuming the
  sale of shares at the midpoint of the Estimated Price Range.  Pro forma
  stockholders' equity per share and pro forma net income per share would be
  $31.51 and $1.90, respectively.  If we were not establishing the Foundation in
  the Stock Conversion, based on Ferguson's estimate, our pro forma
  stockholders' equity would be approximately $55.7 million, or approximately
  17.5% of pro forma consolidated assets at the midpoint of the estimated value,
  and pro forma stockholders' equity per share and pro forma net income per
  share would be $31.84 and $1.86, respectively.  See "Comparison of Valuation
  and Pro Forma Information with No Foundation."

       Regulatory Conditions Imposed on the Foundation.  Establishment of the
  Foundation is subject to certain conditions agreed to by the Foundation in
  writing as a condition to receiving the FDIC's non-objection to and approval

                                       27
of the Stock Conversion, including the following: (i) the Foundation will be
  subject to examination by the FDIC and the Administrator; (ii) the Foundation
  must comply with supervisory directives imposed by the FDIC and the
  Administrator; (iii) the Foundation will operate in accordance with written
  policies adopted by the board of directors, including a conflict of interest
  policy; and (iv) any shares of common stock held by the Foundation must be
  voted in the same ratio as all other outstanding shares of common stock on all
  proposals considered by our stockholders.  The FDIC and the Administrator
  would waive the voting restriction under certain circumstances (and subject to
  additional conditions) if compliance with the voting restriction would: (a)
  cause a violation of the law of the State of North Carolina; (b) would cause
  the Foundation to lose its tax-exempt status or otherwise have a material and
  adverse tax consequence on the Foundation; or (c) would cause the Foundation
  to be subject to an excise tax under Section 4941 of the Code.  In order to
  obtain a waiver, the Foundation's legal counsel would be required to render an
  opinion satisfactory to the FDIC and the Administrator.  There can be no
  assurances that a legal opinion addressing these issues could be rendered, or
  if rendered, that the FDIC and the Administrator would grant unconditional
  waivers of the voting restriction.  In no event would the voting restriction
  survive the sale of shares of the common stock held by the Foundation.

  SUBSCRIPTIONS FOR STOCK IN SUBSCRIPTION AND COMMUNITY OFFERINGS

       Expiration Date.  The Subscription Offering will expire at 12:00 Noon,
  Eastern Time, on __________, 1999 (referred to in this Prospectus as the
  "Expiration Date") unless extended by the Board of Directors of the Bank
  for up to an additional 45 days, to no later than _________, 1999.Subscription
  rights not exercised prior to the Expiration Date will be void. The Community
  Offering, if any, may terminate at any time without notice, but may not
  terminate later than ____________, 1999.

       We will not execute orders until at least the minimum number of shares of
  common stock offered hereby have been subscribed for or sold.  If the minimum
  number of shares of common stock have not been subscribed for or sold within
  45 days of the end of the Subscription Offering (unless such period is
  extended with consent of the Administrator), all funds delivered to us
  pursuant to the Subscription Offering will be promptly returned to the
  subscribers with interest and all charges to savings accounts will be
  rescinded.

       Use of Stock Order Forms and Certification Forms.  Rights to subscribe
  may only be exercised by completion of stock order forms and certification
  forms.  If you receive a stock order form and you desire to subscribe for
  shares of stock, you must do so prior to the Expiration Date by delivering (by
  mail or in person) to any office of the Bank a properly executed and completed
  stock order form and certification form, together with full payment for all
  shares for which the subscription is made.  All checks or money orders must be
  made payable to "1st State Bancorp, Inc."  No photocopies or faxes of stock
  order forms or payment by wire transfer will be accepted.  The stock order
  form and certification form must be received by the Expiration Date. All
  subscription rights under the Plan will expire on the Expiration Date, whether
  or not we have been able to locate each person entitled to such subscription
  rights. ONCE TENDERED, SUBSCRIPTION ORDERS CANNOT BE REVOKED.

       Each subscription right may be exercised only by the person to whom it is
  issued and only for his or her own account.  THE SUBSCRIPTION RIGHTS GRANTED
  UNDER THE PLAN ARE NONTRANSFERABLE.  IF YOU ATTEMPT TO TRANSFER YOUR
  SUBSCRIPTION RIGHTS, YOU MAY LOSE THE RIGHT TO SUBSCRIBE FOR STOCK IN THE
  STOCK CONVERSION AND MAY BE SUBJECT TO OTHER SANCTIONS AND PENALTIES IMPOSED
  BY THE ADMINISTRATOR.  If you subscribe for shares, you will be required to
  represent to us that you are purchasing such shares for your own account and
  that you have no agreement or understanding with any other person for the sale
  or transfer of your shares.

       In the event stock order forms (i) are not delivered and are returned to
  us by the United States Postal Service or we are unable to locate the
  addressee, or (ii) are not returned or are received after the Expiration Date,
  or (iii) are defectively completed or executed, or (iv) are not accompanied by
  the full required payment for the shares subscribed for (including instances
  where a savings account or certificate balance from which withdrawal is
  authorized is insufficient to fund the amount of such required payment), the
  subscription rights of the person to whom such rights

                                       28
have been granted will lapse as though such person failed to return the
  completed stock order form within the time period specified. However, we may,
  but will not be required to, waive any irregularity on any stock order form or
  require the submission of corrected stock order forms or the remittance of
  full payment for subscribed shares by such date as we may specify. Our
  interpretation of the terms and conditions of the Plan and of the stock order
  form will be final.

       Payment for Shares.  Payment for all subscribed shares of common stock
  will be required to accompany all completed stock order forms for
  subscriptions to be valid.  Payment for subscribed shares may be made (i) in
  cash, if delivered in person, (ii) by check or money order, or (iii) by
  authorization of withdrawal from deposit accounts maintained with the Bank.
  Appropriate means by which such withdrawals may be authorized are provided in
  the stock order form.  Once such a withdrawal has been authorized, you may not
  use any of the designated withdrawal amount for any purpose other than to
  purchase stock for which subscription has been made while the Plan remains in
  effect.  In the case of payments authorized to be made through withdrawal from
  deposit accounts, all sums authorized for withdrawal will continue to earn
  interest at the contract rate until the date of consummation of the sale.  In
  the case of payments made in cash or by check or money order such funds will
  be placed in a single segregated savings account established specifically for
  this purpose (with the account as a whole insured by the FDIC up to the
  applicable $100,000 limit) and interest will be paid at our passbook rate from
  the date payment is received until the Stock Conversion is completed or
  terminated.  Interest penalties for early withdrawal applicable to certificate
  accounts will not apply to withdrawals authorized for the purchase of shares.
  If a partial withdrawal results in a certificate account with a balance less
  than the applicable minimum balance requirement, the certificate evidencing
  the remaining balance will earn interest at the Bank's passbook rate
  subsequent to the withdrawal.  An executed stock order form, once received by
  us, may not be modified, amended or rescinded without our consent, unless the
  Stock Conversion is not completed within 45 days of the termination of the
  Subscription Offering.  If an extension of the period of time to complete the
  Stock Conversion is approved by the Administrator, subscribers will be
  resolicited and must affirmatively reconfirm their orders prior to the
  expiration of the resolicitation offering, or their subscription funds will be
  promptly refunded. At this time, subscribers may also modify or cancel their
  subscription at that time. Interest will be paid on such funds at the Bank's
  passbook rate during the 45-day period and any approved extension period.

       If you own a self-directed IRA, you may use the assets of such IRA to
  purchase shares of common stock in the Offering, provided that such self-
  directed IRA is not maintained at the Bank.  If you maintain an IRA at the
  Bank, you must have your account transferred to an unaffiliated institution or
  broker to purchase shares of common stock in the Offering.  If you are
  interested in using funds in a Bank IRA to purchase common stock, you must
  make arrangements with the Stock Information Center at (336) ___-____ no later
  than ___________, 1999 so that the necessary forms may be forwarded for
  execution.

       The ESOP will not be required to pay for the shares subscribed for at the
  time it subscribes, but may pay for such shares upon consummation of the
  Subscription and Community Offerings, if all shares are sold, or upon
  consummation of any subsequent offering, if shares remain to be sold in such
  an offering.

       Shares Purchased.  Certificates representing shares of the common stock
  will be delivered to subscribers as soon as practicable after closing of the
  Stock Conversion.  Shares sold prior to receipt of certificates for the common
  stock are the responsibility of the purchaser.

  PLAN OF DISTRIBUTION AND MARKETING AGENT

       Our officers are available at our offices to provide offering materials,
  to answer questions (but only to the extent such information is derived from
  this Prospectus) and to receive completed stock order forms and certification
  forms.  None of our directors, officers or employees will receive any
  commissions or other compensation for their efforts in connection with sales
  of shares of the common stock.  ALTHOUGH INFORMATION REGARDING THE STOCK
  OFFERING IS AVAILABLE AT OUR OFFICES, AN INVESTMENT IN THE COMMON STOCK IS NOT
  A DEPOSIT, AND THE COMMON STOCK IS NOT FEDERALLY INSURED.

                                       29
Our directors, officers and employees who will be involved in selling
  stock are expected to be exempt from the requirement to register with the SEC
  as broker-dealers within the meaning of Rule 3a4-1 under the Exchange Act.
  Such persons will qualify under the safe harbor provisions of that rule on the
  basis of paragraphs (a)(4)(ii) and/or (iii), i.e., management expects that
  such persons either (x) will perform substantial duties for the Company in its
  business, will not otherwise be broker-dealers and are not expected to
  participate in another offering in the next twelve months or (y) will limit
  their activities to preparing written communications, responding to customer
  inquiries and/or performing ministerial/clerical functions.

       We have engaged Trident Securities as financial advisor to provide sales
  assistance in connection with the Subscription and Community Offerings.  The
  services of Trident Securities will include, but are not limited to, (i)
  training and educating our employees who will be performing certain
  ministerial functions in the Subscription and Community Offerings regarding
  the mechanics and regulatory requirements of the stock sales process and the
  solicitation of proxies from members, (ii) providing employees to staff the
  Stock Information Center, assisting our customers and interested stock
  purchasers and keeping records of orders for shares of common stock, and (iii)
  supervising our sales efforts, including preparation of marketing materials.
  For all its services rendered in the Stock Conversion, Trident Securities will
  receive a commission equal to 1.50% of the aggregate dollar amount of common
  stock sold in the Subscription and Community Offerings, excluding any shares
  of stock sold to our directors, executive officers and the ESOP.
  Additionally, commissions will be excluded on shares sold to "associates" (as
  defined in the Plan) of our directors and executive officers.  In the event
  common stock is sold by other NASD member firms under selected dealer's
  agreements, the aggregate commissions to be received by Trident Securities and
  selected dealers will be agreed upon jointly by us and Trident Securities to
  reflect market requirements at the time of the stock allocation in the
  Syndicated Community Offering and shall not exceed 6%. Trident Securities will
  also be reimbursed for its reasonable out-of-pocket expenses in an amount not
  to exceed $10,000 and its legal fees in an amount not to exceed $27,500. We
  have agreed to indemnify Trident Securities for reasonable costs and expenses
  in connection with certain claims or liabilities, including certain
  liabilities under the Securities Act.

  STOCK PRICING AND NUMBER OF SHARES TO BE ISSUED

       We retained Ferguson, which is experienced in the evaluation and
  appraisal of savings institutions involved in the conversion process, to
  prepare an appraisal of our estimated pro forma market value.  Prior to the
  Conversion, we did not have any business relationship with Ferguson.  Ferguson
  will receive a fixed fee of $30,000 for its appraisal and other services.  We
  have agreed to indemnify Ferguson under certain circumstances against any
  losses, damages, expenses or liability arising out of our engagement of
  Ferguson for the appraisal.

       Ferguson has determined as of October 30, 1998 that the estimated pro
  forma market value of the stock to be issued in the Stock Conversion was
  $30,000,000.  In determining the reasonableness and adequacy of the appraisal
  submitted by Ferguson, the Boards of Directors of the Bank and the Company
  reviewed with Ferguson the methodology and the appropriateness of assumptions
  used by Ferguson in preparing the appraisal.  In consultation with Trident
  Securities, we have determined to offer the shares in the Stock Conversion at
  the Purchase Price of $20.00 per share.  The price per share was determined
  based on a number of factors, including the market price per share of the
  stock of other financial institutions.  With the consent of the Administrator
  and the FDIC, however, the appraiser may establish a range of value for the
  stock of approximately 15% on either side of the estimated value to allow for
  fluctuations in the aggregate value of the stock due to changes in the market
  and other factors from the time of commencement of the Subscription Offering
  until completion of the Community Offering.  Accordingly, Ferguson has
  established a range of value of from $25,500,000 to $34,500,000 for the Stock
  Conversion.  Ferguson will either confirm the continuing validity of its
  appraisal or provide an updated appraisal immediately prior to the completion
  of the Stock Conversion.

       The appraisal has been prepared by Ferguson in reliance upon the
  information contained in this Prospectus, including our consolidated financial
  statements.  Ferguson also considered the following factors, among others:
  the present and projected operating results and financial condition of the
  Bank and the economic and demographic conditions in the Bank's and the
  Company's existing market area; certain historical, financial and other
  information

                                       30
relating to the Bank and the Company; a comparative evaluation of the operating
and financial statistics of the Bank and the Company with those of other
similarly situated savings institutions located in North Carolina and other
regions of the United States; the aggregate size of the offering of common
stock; the impact of the Stock Conversion on the Bank's and the Company's net
worth and earnings potential; the proposed dividend policy of the Company and
the Bank; and the trading market for securities of comparable institutions and
general conditions in the market for such securities.

     Should it be determined at the close of the offering that the aggregate
pro forma market value of the common stock is higher or lower than $30.0
million, but is nonetheless within the Estimated Valuation Range or within 15%
above the maximum of such range, we will make an appropriate adjustment by
raising or lowering the total number of shares issued (within a range from
1,275,000 shares to 1,983,750 shares). Unless permitted by the Company or
otherwise required by the FDIC or the Administrator, we will not resolicit
subscribers and other purchasers because of any such change in the number of
shares to be issued unless the aggregate purchase price of the common stock sold
in the Stock Conversion is below the minimum of the Estimated Valuation Range or
is more than $39,675,000 (i.e., 15% above the maximum of the Estimated Valuation
Range). If the aggregate purchase price falls outside the range of from
$25,500,000 to $39,675,000, you will be resolicited and given the opportunity to
continue your orders, in which case you will need to affirmatively reconfirm
your subscriptions prior to the expiration of the resolicitation, or your
subscription funds will be promptly refunded with interest at our passbook rate.
You will also be given the opportunity to increase, decrease or rescind your
orders. Any change in the Estimated Valuation Range must be approved by the
Administrator. THE ESTABLISHMENT OF ANY NEW PRICE RANGE MAY BE EFFECTED WITHOUT
A RESOLICITATION OF VOTES FROM OUR MEMBERS TO APPROVE THE PLAN.

     THE APPRAISAL IS NOT INTENDED, AND MUST NOT BE CONSTRUED, AS A
RECOMMENDATION OF ANY KIND AS TO THE ADVISABILITY OF PURCHASING THE COMMON
STOCK. IN PREPARING THE VALUATION, FERGUSON HAS RELIED UPON AND ASSUMED THE
ACCURACY AND COMPLETENESS OF FINANCIAL AND STATISTICAL INFORMATION PROVIDED BY
US. FERGUSON DID NOT INDEPENDENTLY VERIFY THE FINANCIAL STATEMENTS AND OTHER
INFORMATION PROVIDED BY US, NOR DID FERGUSON VALUE INDEPENDENTLY OUR ASSETS AND
LIABILITIES. THE VALUATION CONSIDERS US ONLY AS A GOING CONCERN AND SHOULD NOT
BE CONSIDERED AS AN INDICATION OF OUR LIQUIDATION VALUE. MOREOVER, BECAUSE THE
APPRAISAL IS BASED UPON ESTIMATES AND PROJECTIONS OF A NUMBER OF MATTERS WHICH
ARE SUBJECT TO CHANGE, THE MARKET PRICE OF THE COMMON STOCK COULD DECLINE BELOW
$20.00 PER SHARE. COPIES OF THE APPRAISAL REPORT OF FERGUSON SETTING FORTH THE
METHOD AND ASSUMPTIONS FOR THE APPRAISAL ARE ON FILE AND AVAILABLE FOR
INSPECTION AT THE OFFICES SET FORTH UNDER "ADDITIONAL INFORMATION" AND AT OUR
OFFICES. ANY SUBSEQUENT UPDATED APPRAISAL WILL BE FILED WITH THE SEC AND WILL BE
AVAILABLE FOR INSPECTION.

LIMITATIONS ON PURCHASE OF SHARES

     The Plan provides for certain additional limitations to be placed upon the
purchase of shares by eligible subscribers and others in the Stock Conversion.
Each subscriber must subscribe for a minimum of 25 shares. The ESOP may purchase
up to an aggregate of 10% of the shares of the common stock to be issued in the
Stock Conversion and is expected to purchase 8% of such shares. Except for the
ESOP, no Eligible Account Holder, Supplemental Eligible Account Holder or Other
Member, including individuals on a joint account or having the same address on
the Bank's records, may purchase in their capacity as such in the Subscription
Offering more than 50,000 shares, or $1,000,000, of common stock. No person,
including associates of and persons acting in concert with such person,
including individuals on a joint account or having the same address on the
Bank's records, may purchase in the Community Offering more than 50,000 shares,
or $1,000,000, of common stock. No person, including associates of and persons
acting in concert with such person (other than the ESOP), including individuals
on a joint account or having the same address on the Bank's records, may
purchase in the Stock Conversion more than $1,000,000, or 50,000 shares of
common stock. Shares purchased by the ESOP and attributable to a participant
thereunder shall not be aggregated with shares purchased by such participant or
any other purchaser of common stock in the Stock Conversion. For purposes of the
Plan, our directors are not deemed to be associates or a group acting in concert
solely by reason of their Board membership.

                                       31
Subject to any required regulatory approval and the requirements of
applicable laws and regulations, but without further approval of our members,
the purchase limitations may be increased or decreased at our sole discretion at
any time. If such amount is increased, subscribers for the maximum amount will
be given the opportunity to increase their subscriptions up to the then
applicable limit, subject to the rights and preferences of any person who has
priority subscription rights. In the event that the purchase limitation is
decreased after commencement of the Subscription and Community Offerings, the
orders of any person who subscribed for the maximum number of shares of common
stock shall be decreased by the minimum amount necessary so that such person
shall be in compliance with the then maximum number of shares permitted to be
subscribed for by such person.

     The term "associate" of a person is defined to mean: (i) any corporation
or organization (other than the Bank, the Company, or a majority-owned
subsidiary of the Bank or the Company) of which such person is an officer or
partner or is directly or indirectly the beneficial owner of 10% or more of any
equity securities; (ii) any trust or other estate in which such person has a
substantial beneficial interest or as to which such person serves as a trustee
or in a similar fiduciary capacity, except that such term shall not include any
tax-qualified employee stock benefit plan of ours in which such person has a
substantial beneficial interest or serves as a trustee or in a similar fiduciary
capacity; and (iii) any relative or spouse of such person, or any relative of
such spouse, who either has the same home as such person or who is a director of
the Bank or the Company or any of their subsidiaries. Directors are not treated
as associates solely because of their Board membership.

     The term "acting in concert" means (i) knowing participation in a joint
activity or interdependent conscious parallel action towards a common goal
whether or not pursuant to an express agreement; or (ii) a combination or
pooling of voting or other interests in the securities of an issuer for a common
purpose pursuant to any contract, understanding, relationship, agreement or
other arrangement, whether written or otherwise. We may presume that certain
persons are acting in concert based upon, among other things, joint account
relationships, common addresses and the fact that such persons have filed joint
Schedule 13Ds with the SEC with respect to other companies.

     Each person purchasing common stock in the Stock Conversion shall be
deemed to confirm that such purchase does not conflict with the purchase
limitations under the Plan or otherwise imposed by law, rule or regulation. In
the event that such purchase limitations are violated by any person (including
any associate or group of persons affiliated or otherwise acting in concert with
such person), we shall have the right to purchase from such person at the
aggregate purchase price all shares acquired by such person in excess of such
purchase limitations or, if such excess shares have been sold by such person, to
receive the difference between the aggregate purchase price paid for such excess
shares and the price at which such excess shares were sold by such person. Our
right to purchase such excess shares shall be assignable by us. In addition,
persons who violate the purchase limitations may be subject to sanctions and
penalties imposed by the Administrator.

     In addition, under guidelines of the NASD, members of the NASD and their
associates are subject to certain restrictions on the transfer of securities
purchased in accordance with subscription rights and to certain reporting
requirements upon purchase of such securities.

     Depending upon market conditions, the Boards of Directors of the Company
and the Bank, with the approval of the Administrator, may increase or decrease
any of the above purchase limitations. In the event of such an increase or
decrease, no further approval of our members would be required. North Carolina
regulations authorize a plan of conversion to provide a maximum purchase
limitation of a percentage not to exceed 5% except for tax-qualified employee
stock benefit plans which may purchase in the aggregate not more than 10%.

                                       32
RESTRICTIONS ON REPURCHASE OF STOCK

     Upon consummation of the Bank Conversion, our ability to repurchase our
capital stock will be governed by the Federal Reserve Board's regulations. Under
the Federal Reserve Board's regulations, any bank holding company that is not
well-capitalized and not in generally satisfactory condition must notify the
Federal Reserve Board before purchasing or redeeming its equity securities if
the gross consideration for the purchase or redemption, when aggregated with the
net consideration paid by the company for all purchases and redemptions during
the preceding 12 months, is equal to 10% or more of the company's consolidated
net worth. The Federal Reserve Board may disapprove a proposed purchase or
redemption if it finds that the proposal would constitute an unsafe or unsound
practice or would violate any directive of, condition imposed by or written
agreement with, the Federal Reserve Board. Under the Federal Reserve Board's
regulations, no such prior notice of repurchases is required to be given by a
bank holding company that has received one of the two highest examination
ratings at its most recent supervisory inspection, is not the subject of any
unresolved supervisory issues and is, and after giving effect to the proposed
repurchase will continue to be, well-capitalized. We do not have any specific
plans regarding possible stock repurchases during the first year following the
Stock Conversion.

LIMITATIONS ON RESALES BY MANAGEMENT

     Shares of the common stock purchased by our directors or executive
officers and those of the Company in the Stock Conversion will be subject to the
restriction that such shares may not be sold for a period of one year following
completion of the Stock Conversion, except in the event of the death of the
original purchaser or in any exchange of such shares in connection with a merger
or acquisition of the Company approved by the applicable regulatory authorities.
Accordingly, shares of the common stock issued to directors and executive
officers shall bear a legend giving appropriate notice of the restriction
imposed upon it. In addition, we will give appropriate instructions to the
transfer agent for the common stock with respect to the applicable restriction
for transfer of any restricted stock. Any shares issued to directors and
executive officers as a stock dividend, stock split or otherwise with respect to
restricted stock shall be subject to the same restrictions. Shares acquired
otherwise than in the Stock Conversion, such as under the stock option plan,
would not be subject to such restrictions. To the extent directors and executive
officers are deemed affiliates of the Company, all shares of the common stock
acquired by such directors and officers will be subject to certain resale
restrictions and may be resold pursuant to Rule 144 under the Securities Act.
See "Regulation -- Regulation of the Company -- Federal Securities Law."

INTERPRETATION AND AMENDMENT OF THE PLAN

     To the extent permitted by law, our interpretations of the Plan will be
final. The Plan provides that our Board of Directors shall have the sole
discretion to interpret and apply the provisions of the Plan to particular facts
and circumstances and to make all determinations necessary or desirable to
implement such provisions, including but not limited to matters with respect to
giving preference in the Community Offering to natural persons and trusts of
natural persons who are permanent residents of Alamance County, North Carolina.
Any and all interpretations, applications and determinations made by the Board
of Directors in good faith and on the basis of such information and assistance
as was then reasonably available for such purpose shall be conclusive and
binding upon us and our members and subscribers in the Subscription and
Community Offerings, subject to the authority of the FDIC and the Administrator.

     The Plan provides that, if deemed necessary or desirable by the Board of
Directors, the Plan may be substantively amended by a two-thirds vote of the
Board of Directors at any time prior to submission of the Plan and proxy
materials to our members. After submission of the Plan and proxy materials to
the members, the Plan may be amended by a two-thirds vote of the Board of
Directors at any time prior to the Special Meeting and at any time following the
Special Meeting with the concurrence of the FDIC and the Administrator. In its
discretion, the Board of Directors may modify or terminate the Plan upon the
order of the regulatory authorities without a resolicitation of proxies or
another Special Meeting. However, any modification of the Plan resulting in a
material change in the terms of the Conversion would require a resolicitation of
proxies and another meeting of members.

                                       33
The Plan further provides that in the event that mandatory new regulations
pertaining to conversions are adopted by the FDIC, the Administrator, the
Commission, the Federal Reserve Board or any successor agency prior to
completion of the Conversion, the Plan will be amended to conform to such
regulations without a resolicitation of proxies or another Special Meeting. In
the event that such new conversion regulations contain optional provisions, the
Plan may be amended to utilize such optional provisions at the discretion of the
Board of Directors without a resolicitation of proxies or another Special
Meeting. By adoption of the Plan, our members will be deemed to have authorized
amendment of the Plan under the circumstances described above.

CONDITIONS AND TERMINATION

     Completion of the Conversion requires the approval of the Plan by the
affirmative vote of not less than a majority of the total outstanding votes of
our members and the sale of all shares of the common stock within 12 months
following approval of the Plan by the members. Such time period may be extended
an additional 12 months by an amendment to the Plan. If these conditions are not
satisfied, the Plan will be terminated, and we will continue our business in the
mutual form of organization. The Board of Directors may terminate the Plan at
any time prior to the Special Meeting and, with the approval of the FDIC and the
Administrator, at any time after the Special Meeting.

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

GENERAL

     1st State Bancorp, Inc. has only recently been formed and, accordingly,
has no results of operations at this time. As a result, this discussion relates
to the financial condition and results of operations of the Bank.

     Our business consists principally of attracting deposits from the general
public and investing these funds in loans secured by single-family residential
and commercial real estate, secured and unsecured commercial loans and consumer
loans. Our profitability depends primarily on our net interest income which is
the difference between the income we receive on our loan and investment
securities portfolios and our cost of funds, which consists of interest paid on
deposits and borrowed funds. Net interest income also is affected by the
relative amounts of interest-earning assets and interest-bearing liabilities.
When interest-earning assets approximate or exceed interest bearing liabilities,
any positive interest rate spread will generate net interest income. Our
profitability also is affected by the level of other income and operating
expenses. Other income consists of miscellaneous fees related to our loans and
deposits, mortgage banking income and commissions from sales of annuities and
mutual funds. Operating expenses consist of compensation and benefits, occupancy
related expenses, federal deposit insurance premiums, data processing,
advertising and other expenses.

     Our operations are influenced significantly by local economic conditions
and by policies of financial institution regulatory authorities. Our cost of
funds is influenced by interest rates on competing investments and by rates
offered on similar investments by competing financial institutions in our market
area, as well as general market interest rates. Lending activities are affected
by the demand for financing of real estate and other types of loans, which in
turn is affected by the interest rates at which such financing may be offered.

     Our business emphasis has been to operate as a well-capitalized, profitable
and independent community-oriented financial institution dedicated to providing
quality customer service. We are committed to meeting the financial needs of the
communities in which we operate. We believe that we can be more effective in
servicing our customers than many of our nonlocal competitors because of our
ability to quickly and effectively provide senior management responses to
customer needs and inquiries. Our ability to provide these services is enhanced
by the stability of our senior management team.

                                       34
Beginning in the late 1980's, we have sought to gradually increase the
percentage of our assets invested in commercial real estate loans, commercial
loans and consumer loans, which have higher interest rates and shorter terms and
adjust more frequently to changes in interest rates than single-family
residential mortgage loans. At September 30, 1998, commercial real estate,
commercial and consumer loans totaled $38.8 million, $25.2 million and $6.3
million, respectively, which represented 18.8%, 12.2% and 3.1%, respectively, of
gross loans. At September 30, 1998, $100.9 million, or 48.8% of gross loans,
consisted of residential real estate mortgage loans. Following the Conversion,
we intend to continue to follow our current strategy of seeking growth
opportunities through increasing our portfolio of commercial real estate,
commercial and consumer loans while continuing to pursue single-family
residential mortgage loan origination activities.

YEAR 2000 COMPLIANCE

     Our operations, like those of most financial institutions, are
substantially dependent upon computer systems for our lending and deposit
activities. We are addressing the potential problems associated with the
possibility that the computers which control our data processing activities,
facilities and networks may not be programmed to read four-digit dates and, upon
the arrival of the year 2000, may recognize the two-digit code "00" as the year
1900 rather than 2000. This could cause systems to fail to function or generate
erroneous information.

     We formed a Year 2000 Committee early in 1998 with senior representatives
from every functional area of our Bank. At the direction of the Board, this
Committee is leading our efforts to ensure that we are ready for the Year 2000.
Our Board of Directors has approved the Bank's five phase Year 2000 Plan that
was developed in accordance with the guidelines set forth by the Federal
Financial Institutions Examination Council.

     The first phase, awareness, was intended to provide on-going information
to our employees, directors and customers of the impact of the Year 2000 issue.
We have conducted Year 2000 training for all directors and employees.

     The second phase, assessment, required us to review all systems that we
believe to be potential risks in order to minimize any Year 2000 operating
difficulties. This review included all major computer and non-computer based
systems, such as vaults, security systems and telephone systems. In April 1998,
we converted to a new computer system for processing all loan, deposit and
general ledger transactions. In conjunction with this conversion, we purchased
and installed new hardware and software throughout the Bank. The hardware and
software purchased are Year 2000 compliant or will be with minor modifications
or upgrades. The combined cost of this hardware and software was $1.2 million,
which was capitalized during the year ended September 30, 1998 in accordance
with our capitalization policy. This phase is virtually complete, and we are
following up on any remaining issues to complete our thorough assessment.

     The third phase, renovation and/or replacement, includes obtaining vendor
certification and/or the necessary upgrades and enhancements to ensure that our
existing systems are Year 2000 compliant. We are continuing to follow up with
third party vendors as necessary. At this time we have plans in place for all
mission critical systems to be compliant by December 31, 1998.

     The fourth phase, testing, is currently underway. The hardware has been
successfully tested, and we have begun testing the software. We have received
representations from our mission critical third party vendors that they are Year
2000 compliant. All testing is expected to be completed by January 31, 1999 and
any problems would be remedied by March 31, 1999.

     The last phase, implementation, will commence in the second quarter of
1999, ending with the first quarter of 2000. We are currently in the process of
developing contingency plans for processes that are not Year 2000 compliant. We
expect this contingency plan to be ready by March 31, 1999.

     We estimate that the total future cost of Year 2000 compliance, excluding
internal staffing costs, will not exceed $15,000. This estimate includes the
cost of an independent consultant that has been retained to assist us in

                                       35
evaluating our Year 2000 Plan and assist us in testing. We believe that our
policies, plans and actions are in compliance with regulatory guidelines and
milestone dates.

     Our customers may also experience Year 2000 problems, which could
adversely affect their ability to comply with their obligations to us. We have
assessed all significant commercial loan customers to determine their Year 2000
readiness. Although Year 2000 readiness varies among our customers, we do not
expect that Year 2000 problems will have such a serious impact on our customers
as to cause them to suffer material adverse financial consequences.

     We believe that the potential effects on our internal operations from
Year 2000 issues can and will be addressed prior to the Year 2000. However, as
unforeseen circumstances arise, the Year 2000 issue could disrupt our normal
business operations. The most reasonably likely worst case Year 2000 scenarios
foreseeable at this time would include our not being able to systematically
process, in some combination, various types of customer transactions. This could
affect our ability to accept deposits or process withdrawals, originate new
loans or accept loan payments in the automated manner we currently utilize.
Depending upon how long this scenario lasted, this could have a material adverse
effect on our operations. Our contingency plan will address alternative methods
to enable us to continue to offer basic services to our customers. The costs of
our Year 2000 project and our benchmark dates are based on our best estimates,
which are based on a number of assumptions including future events. We cannot
guarantee that these estimates will be achieved at the cost disclosed or within
the time frames indicated.

LIQUIDITY AND CAPITAL RESOURCES

     Following the completion of the Stock Conversion, the Company initially
will have no business other than that of the Converted Bank and investing the
net Stock Conversion proceeds retained by it. Management believes that the net
proceeds to be retained by the Company, earnings on such proceeds and principal
and interest payments on the ESOP loan, together with dividends that may be paid
from the Converted Bank to the Company following the Stock Conversion, will
provide sufficient funds for its initial operations and liquidity needs;
however, no assurance can be given that the Company will not have a need for
additional funds in the future. The Converted Bank will be subject to certain
regulatory limitations with respect to the payment of dividends to the Company.
See "Dividend Policy" and "Regulation --Depository Institution Regulation --
Dividend Restrictions." The Company intends to lend a portion of the net
proceeds retained from the Stock Conversion to the ESOP to fund the ESOP's
purchase of common stock in the Stock Conversion. See "Use of Proceeds."

     At September 30, 1998, we had net worth of $26.0 million compared to
$23.3 million at September 30, 1997. We reported net income for the year ended
September 30, 1998 of $2.5 million, as compared to $2.5 million and $1.6 million
for the years ended September 30, 1997 and 1996, respectively. At September 30,
1998 and 1997, we had a capital to total assets ratio of 14.5% and 14.1%,
respectively. At September 30, 1998, we had Tier 1 leverage capital, Tier 1 
risk-based capital, and total risk-based capital of $25.9 million, $25.9 million
and $28.1 million, respectively.

     At September 30, 1998, we exceeded all regulatory minimum capital
requirements. For a detailed discussion of the Administrator's and FDIC's
regulatory capital requirements, and for a tabular presentation of our
compliance with such requirements, see "Regulation -- Depository Institution
Regulation -- Capital Requirements."

     For additional information regarding our actual, pro forma and minimum
required capital ratios at September 30, 1998, see "Historical and Pro Forma
Regulatory Capital Compliance." The Converted Bank will, as a result of the
Stock Conversion, have substantially increased capital. There can be no
assurance, however, that the Company's sources of funds will be sufficient to
satisfy the liquidity needs of the Company in the future.

     Our primary sources of funds are deposits, principal and interest
payments on loans, proceeds from the sale of loans, and to a lesser extent,
advances from the FHLB of Atlanta. While maturities and scheduled amortization
of loans are predictable sources of funds, deposit flows and mortgage
prepayments are greatly influenced by general interest rates, economic
conditions and local competition.

                                       36
Our primary investing activities have been the origination of loans and
the purchase of investment securities. During the years ended September 30,
1998, 1997 and 1996, we had $105.4 million, $79.2 million and $62.9 million,
respectively, of loan originations. During the years ended September 30, 1998,
1997 and 1996, we purchased investment securities in the amounts of $34.6
million, $7.0 million and $16.4 million, respectively. Our primary financing
activities are the attraction of savings deposits and, during the year ended
September 30, 1998, obtaining FHLB advances.

     The Administrator's regulations require savings banks to maintain liquid
assets equal to at least 10% of total assets. The computation of liquidity under
the Administrator's Regulations allows the inclusion of investments with readily
marketable value, including investments with maturities in excess of five years.
Our average liquidity ratios were 20.6%, 18.3%, and 19.4% for the years ended
September 30, 1998, 1997, and 1996, respectively. We have maintained high
liquidity ratios in recent years in anticipation of our conversion to a
commercial bank. Commercial banks generally are subject to higher liquidity
requirements than savings banks. Our most liquid assets are cash and cash
equivalents. The levels of these assets are dependent on our operating,
financing, lending and investing activities during any given period. At
September 30, 1998 and 1997, cash and cash equivalents totaled $31.1 million and
$15.0 million, respectively. We have other sources of liquidity should we need
additional funds. During the years ended September 30, 1998, 1997 and 1996, we
sold loans totaling $27.6 million, $9.2 million and $9.2 million, respectively.
Additional sources of funds include FHLB of Atlanta advances. During the year
ended September 30, 1998, we obtained $20.0 million of FHLB of Atlanta advances
with maturities matched to the repricing of a comparable amount of loans to
reduce our exposure to potentially rising interest rates. See " --
Asset/Liability Management." At September 30, 1998, we had $20.0 million of FHLB
of Atlanta advances outstanding, compared to $1.0 million at September 30, 1997.
Other sources of liquidity include loans and investment securities designated as
available for sale, which totaled $7.5 million and $9.9 million, respectively,
at September 30, 1998.

     We anticipate that we will have sufficient funds available to meet our
current commitments. At September 30, 1998, we had $7.5 million in commitments
to originate new loans, $40.4 million in unfunded commitments to extend credit
under existing equity line and commercial lines of credit and $505,000 in
standby letters of credit. At September 30, 1998, certificates of deposit which
are scheduled to mature within one year totaled $116.5 million. We believe that
a significant portion of such deposits will remain with us. However, some of
these deposits may be used to buy stock in the Offering.

ASSET/LIABILITY MANAGEMENT

     Net interest income, the primary component of our net income, is derived
from the difference or "spread" between the yield on interest-earning assets and
the cost of interest-bearing liabilities. We strive to achieve consistent net
interest income and to reduce our exposure to changes in interest rates by
matching the terms to repricing of our interest-sensitive assets and
liabilities. The matching of our assets and liabilities may be analyzed by
examining the extent to which our assets and liabilities are interest rate
sensitive and by monitoring the expected effects of interest rate changes on our
net interest income. Factors beyond our control, such as market interest rates
and competition, may also have an impact on our interest income and interest
expense.

     In the absence of any other factors, the overall yield or return
associated with our earning assets generally will increase from existing levels
when interest rates rise over an extended period of time, and conversely
interest income will decrease when interest rates decrease. In general, interest
expense will increase when interest rates rise over an extended period of time,
and conversely interest expense will decrease when interest rates decrease.
Therefore, by controlling the increases and decreases in its interest income and
interest expense which are brought about by changes in market interest rates, we
can significantly influence our net interest income.

     Our President reports to our Board of Directors on a regular basis on
interest rate risk and trends, as well as liquidity and capital ratios and
requirements. The Board of Directors reviews the maturities of our assets and
liabilities and establishes policies and strategies designed to regulate our
flow of funds and to coordinate the sources, uses and

                                       37
pricing of such funds. The first priority in structuring and pricing our assets
and liabilities is to maintain an acceptable interest rate spread while reducing
the net effects of changes in interest rates. Our management is responsible for
administering the policies and determinations of the Board of Directors with
respect to our asset and liability goals and strategies.

     Our principal strategy in managing our interest rate risk has been to
increase interest rate sensitive assets such as commercial loans and consumer
loans. At September 30, 1998, we had $25.2 million of commercial loans and $6.3
million of consumer loans, which amounted to 12.2% and 3.1%, respectively, of
our gross loan portfolio, as compared to $22.9 million of commercial loans and
$5.4 million of consumer loans, respectively, at September 30, 1997, which
amounted to 11.3% and 2.7%, respectively, of our gross loan portfolio at that
date. In addition, in managing our portfolio of investment securities in recent
periods we emphasized the purchase of short-term securities so as to reduce our
exposure to increases in interest rates. In addition, at September 30, 1998, we
had $7.5 million of loans held for sale, and, pursuant to SFAS No. 115,
"Accounting for Certain Investments in Debt and Equity Securities", we had
investment securities with an aggregate amortized cost of $9.7 million and an
aggregate fair value of $9.9 million as available for sale. We are holding these
loans and investment securities as available for sale so that they may be sold
if needed for liquidity or asset and liability management purposes.

     We also have shortened the average repricing period of our assets by
retaining in our portfolio single-family residential mortgage loans only in
cases where the loan carries an adjustable rate or the loan has an interest rate
that is sufficient to compensate us for the risk of maintaining long-term, 
fixed-rate loans in our portfolio. During the past two years, we have sold a
significant portion of our fixed-rate, single-family residential mortgage loans
with terms of 15 years or more we have originated, and at September 30, 1998,
most of our single-family residential mortgage loans classified as held to
maturity were originated at least two years previously when market interest
rates were higher. At September 30, 1998, we held approximately $32.1 million of
adjustable-rate residential mortgage loans, which represented approximately
15.5% of our gross loan portfolio. Depending on conditions existing at any given
time, as part of our interest rate risk management strategy, we may sell newly
originated fixed-rate residential mortgage loans with original maturities of 15
years or more in the secondary market.

     In addition, in early 1998, as market interest rates were falling and our
yields on newly originated fixed-rate loans were decreasing, we became
increasingly concerned that if interest rates were to increase significantly
from the low rates then prevailing our cost of funds could be expected to
increase while we would continue to earn the same low yield on our fixed-rate
loans. To reduce our interest rate risk, in February 1998, we obtained $20.0
million in fixed-rate FHLB of Atlanta advances. These advances were structured
with maturities estimated to coincide with the expected repricing of
approximately $20.0 million of our loans. Through this strategy, we were able to
establish a positive interest rate spread on the $20.0 million of assets and
FHLB of Atlanta advances. The FHLB of Atlanta advances may not be prepaid, and
since the time the advances were obtained interest rates have declined, with the
result that we have been and currently are earning a lesser interest rate spread
than we would otherwise be earning had we not obtained the advances. However,
the strategy of obtaining FHLB advances with maturities matched to a comparably
sized portfolio of interest-earning assets has helped us to significantly reduce
our interest rate risk in times of rising interest rates with respect to that
portion of our assets and liabilities.

INTEREST RATE SENSITIVITY ANALYSIS

     The matching of assets and liabilities may be analyzed  by examining the
extent to which such assets and liabilities reprice in response to changes in
interest rates. The interest rate gap is defined as the difference between the
amount of interest-earning assets maturing or repricing within a specific time
period and the amount of interest-bearing liabilities that will mature or
reprice within the same time period. At September 30, 1998 our cumulative
interest rate gap (which is the difference between the amount of interest-
earning assets and interest-bearing liabilities maturing or repricing within one
year) as a percentage of total assets was a negative 2.4%. A gap is considered
positive when the amount of interest rate sensitive assets exceeds the amount of
interest rate sensitive liabilities. Conversely, a gap is considered negative
when the interest rate sensitive liabilities exceed the interest rate sensitive
assets.

                                       38
The following table sets forth the amounts of interest-earning assets and
interest-bearing liabilities outstanding at September 30, 1998 which are
anticipated by the Bank based upon certain assumptions, to reprice or mature in
each of the future time periods shown.
More than    More than
                                              3 months    4 to 12   1 year to     3 years      Over
                                               or less    months     3 years    to 5 years   5 years    Total
                                               -------    ------     -------    ----------   -------    -----  
                                                                 (Dollars In thousands)
Interest-earning assets:
   Loans receivable (1).....................   $73,237   $ 31,977    $ 32,288      $37,193   $29,627   $204,322
   Investment securities (2)................        --      3,992       9,484        7,000    20,923     41,399
   Interest-bearing overnight deposits......    25,559         --          --           --        --     25,559
                                               -------   --------    --------      -------   -------   --------
 
        Total interest-earning assets.......    98,796     35,969      41,772       44,193    50,550    271,280
 
Interest-bearing liabilities:
   Transaction accounts.....................     7,013     12,724       9,950        2,966     5,665     38,318
   Passbook and statement...................     1,279      3,497       7,253        4,729    11,333     28,091
   Certificates of deposit..................    38,881     78,156      35,406        8,218        --    160,661
   FHLB advances............................        --         --          --           --    20,000     20,000
                                               -------   --------    --------      -------   -------   --------
        Total interest-bearing liabilities..    47,173     94,377      52,609       15,913    36,998    247,070
 
Interest sensitivity gap....................   $51,623   $(58,408)   $(10,837)     $28,280   $13,552   $ 24,210
                                               =======   ========    ========      =======   =======   ========
Cumulative interest sensitivity gap.........   $51,623   $ (6,785)   $(17,622)     $10,658   $24,210
                                               =======   ========    ========      =======   =======
Ratio of cumulative gap to total
   interest-earning assets..................      19.0%      (2.5)%      (6.5)%        3.9%      8.9%
                                               =======   ========    ========      =======   =======
Ratio of cumulative gap to total
   assets...................................      17.9%      (2.4)%      (6.1)%        3.7%      8.4%
                                               =======   ========    ========      =======   =======
Ratio of interest-earning assets to
   interest-bearing liabilities.............     209.4%      38.1%       79.4%       277.7%    136.6%
                                               =======   ========    ========      =======   =======
____________
(1)  Includes nonaccrual loans and loans held for sale.
(2)  Includes FHLB of Atlanta stock.
 
MARKET RISK

     Market risk reflects the risk of economic loss resulting from adverse
changes in market prices and interest rates. The risk of loss can be reflected
in diminished current market values and/or reduced potential net interest income
in future periods.

     Our market risk arises primarily from interest rate risk inherent in our
lending and deposit-taking activities. We do not maintain a trading account for
any class of financial instrument nor do we engage in hedging activities or
purchase high-risk derivative instruments. Furthermore, we are not subject to
foreign currency exchange rate risk or commodity price risk. For additional
information regarding the sensitivity to interest rate risk of the Bank's
interest-earning assets and interest-bearing liabilities, see the table under
"Business of 1st State Bank -- Lending Activities -- Loan Maturity Schedule," 
" -- Investment Activities" and "-- Deposit Activity and Other Sources of
Funds."

     We measure our interest rate risk by computing estimated changes in net
interest income and the net portfolio value ("NPV") of cash flows from assets,
liabilities and off-balance sheet items in the event of a range of assumed
changes in market interest rates. These computations estimate the effect on our
net interest income and NPV of sudden and sustained 1% to 4% increases and
decreases in market interest rates. Our Board of Directors has adopted an
interest rate risk policy which establishes maximum decreases in our estimated
net interest income of 10%, 15%, 20% and 25% in the event of 1%, 2%, 3% and 4%
increases and decreases in the market interest rates, respectively. Limits have
also been established for changes in NPV of decreases of 10%, 15%, 25% and 50%
in the event of 1%, 2%, 3% 

                                       39
and 4% increases in market interest rates, respectively, and decreases of 5%,
10%, 15% and 20% in the event of 1%, 2%, 3% and 4% decreases in market interest
rates, respectively. The following table presents the projected change in net
interest income and NPV for the various rate shock levels at September 30, 1998.
Net Portfolio Value                  Net Interest Income
 Change        ---------------------------------      ---------------------------------
in Rates       $ Amount    $ Change    % Change       $ Amount    $ Change     % Change
--------       --------    --------    --------       --------    --------     --------
                                          (Dollars in thousands)
+ 400  bp      28,281     $(5,254)     (15.67)%       $9,478     $ 1,012         11.95%
+ 300  bp      29,839      (3,696)     (11.02)         9,240         774          9.13
+ 200  bp      31,397      (2,138)      (6.37)         9,002         536          6.32
+ 100  bp      32,466      (1,069)      (3.19)         8,734         268          3.16
Static         33,535           0        0.00          8,466           0          0.00
- 100  bp      33,638         103        0.31          8,082        (384)        (4.54)
- 200  bp      33,742         207        0.62          7,697        (769)        (9.09)
- 300  bp      33,156        (379)      (1.13)         7,265      (1,201)       (14.19)
- 400  bp      32,571        (964)      (2.87)         6,832      (1,634)       (19.30)
The above table indicates that at September 30, 1998, in the event of
sudden and sustained increases in prevailing market interest rates, our
estimated net interest income would be expected to increase and our NPV would be
expected to decrease, and that in the event of sudden and sustained decreases in
prevailing market interest rates, our estimated net interest income and NPV
would be expected to decrease, except that our NPV would be expected to increase
in the event of a sudden and sustained decrease in interest rates of 100 or 200
basis points. Our Board of Directors reviews our net interest income and NPV
position quarterly, and, if estimated changes in net interest income and NPV are
not within the targets established by the Board, the Board may direct management
to adjust the asset and liability mix to bring interest rate risk within Board
approved targets. At September 30, 1998, our estimated changes in net interest
income and NPV were within the targets established by the Board of Directors.

     Computations of prospective effects of hypothetical interest rate
changes, such as the above computations, are based on numerous assumptions,
including relative levels of market interest rates, loan prepayments and deposit
decay, and should not be relied upon as indicative of actual results. Further,
the computations do not contemplate any actions we may undertake in response to
changes in interest rates.

     Certain shortcomings are inherent in the method of analysis presented in
the above tables. For example, although certain assets and liabilities may have
similar maturities or periods to repricing, they may react in differing degrees
to changes in market interest rates. The interest rates on certain types of
assets and liabilities may fluctuate in advance of changes in market interest
rates, while interest rates on other types may lag behind changes in market
rates. Additionally, certain assets, such as adjustable-rate loans, have
features which restrict changes in interest rates on a short-term basis and over
the life of the asset. In addition, the proportion of adjustable-rate loans in
our portfolio could decrease in future periods if market interest rates remain
at or decrease below current levels due to refinance activity. Further, in the
event of a change in interest rates, prepayment and early withdrawal levels
would likely deviate significantly from those assumed in the table. Also, the
ability of borrowers to repay their adjustable-rate debt may decrease in the
event of an interest rate increase.

ANALYSIS OF NET INTEREST INCOME

     Net interest income represents the difference between income derived from
interest-earning assets and the interest expense on interest-bearing
liabilities. Net interest income is affected by both (i) the difference between
the rates of interest earned on interest-earning assets and the rates paid on
interest-bearing liabilities ("interest rate spread") and (ii) the relative
volume of interest-earning assets and interest-bearing liabilities.

                                       40
The following table sets forth certain information relating to our
consolidated balance sheets at September 30, 1998 and our consolidated
statements of income for the years ended September 30, 1998, 1997, and 1996 and
reflects the average yield on assets and average cost of liabilities at the date
and for the periods indicated. Such yields and costs are derived by dividing
income or expense by the average balance of assets and liabilities,
respectively, for the periods shown. Average balances are derived from daily
balances.
Year Ended September 30,
                                 ---------------------------------------------------------------------------------------------
                                 At September 30 1998                1998                                  1997 
                                 --------------------     ----------------------------       ---------------------------------
                                                                               Average                                 Average 
                                            Yield/        Average              Yield/         Average                  Yield/ 
                                  Balance    Cost         Balance   Interest    Cost          Balance     Interest      Cost  
                                 ---------  -------       --------  --------  --------        --------    --------    --------
                                                                                (Dollars in thousands)
.............................
Assets:
  Loans receivable (1)..........  $204,322    8.28%       $199,203   $17,185     8.63%        $186,413     $16,167       8.67%
  Investment securities (2).....    41,399    6.26          35,938     2,320     6.46           39,101       2,557       6.54
  Interest-bearing
   overnight deposits...........    25,559    5.75          20,409     1,203     5.89            6,116         337       5.51
                                  --------                --------   -------                  --------     -------
    Total interest-earning
     assets.....................   271,280    7.74         255,550    20,708     8.10          231,630      19,061       8.23
                                                                     -------                               -------
Non-interest-earning assets.....    16,943                  17,499                              15,362
                                  --------                --------                            --------
    Total assets................  $288,223                $273,049                            $246,992
                                  ========                ========                            ========

Liabilities and net worth:
  Deposits......................  $227,070    4.57        $224,334    10,331     4.61         $215,494       9,743       4.52
  FHLB advances.................    20,000    5.39          13,559       740     5.46            1,000          56       5.60
                                  --------                --------   -------                  --------     -------
    Total interest-bearing
     liabilities................   247,070    4.63         237,893    11,071     4.65          216,494       9,799       4.53
                                              ----                   -------  -------                      -------    -------
Non-interest-bearing
 liabilities....................    15,187                  10,436                               8,026
                                  --------                --------                            --------
    Total liabilities...........   262,257                 248,329                             224,520
Net worth.......................    25,966                  24,720                              22,472
                                  --------                --------                            --------
    Total liabilities and
     net worth..................  $288,223                $273,049                            $246,992
                                  ========                ========                            ========

Net interest income.............                                     $ 9,637                               $ 9,262
                                                                     =======                               =======
Interest rate spread............              3.11%                              3.45%                                   3.70%
                                          ========                            =======                                 =======
Net interest margin (3).........                                                 3.77%                                   4.00%
                                                                              =======                                 =======
Ratio of average
 interest-earning assets
  to average interest-bearing
   liabilities..................            109.80%                            107.42%                                 106.99%
                                          ========                            =======                                 =======
--------------------------------
                                              1996
                                 --------------------------------
                                                         Average
                                 Average                  Yield/
                                 Balance     Interest      Cost
                                 --------    --------    --------
Assets:
  Loans receivable (1).......... $171,148     $14,620       8.54%
  Investment securities (2).....   37,854       2,402       6.35
  Interest-bearing
   overnight deposits...........    6,605         373       5.65
                                 --------     -------
    Total interest-earning
     assets.....................  215,607      17,395       8.07
                                              -------
Non-interest-earning assets.....   13,313
                                 --------
    Total assets................ $228,920
                                 ========

Liabilities and net worth:
  Deposits......................  202,776       9,450       4.66
  FHLB advances.................      156           3       1.92
                                 --------     -------
    Total interest-bearing
     liabilities................  202,932       9,453       4.66
                                              -------    -------
Non-interest-bearing
 liabilities....................    5,842
                                 --------
    Total liabilities...........  208,774
Net worth.......................   20,146
                                 --------
    Total liabilities and
     net worth.................. $228,920
                                 ========

Net interest income.............              $ 7,942
                                              =======
Interest rate spread............                            3.41%
                                                         =======
Net interest margin (3).........                            3.68%
                                                         =======
Ratio of average
 interest-earning assets
  to average interest-bearing
   liabilities..................                          106.25%
                                                          ======
--------------------
(1)  Includes nonaccrual loans and loans held for sale.
(2)  Includes FHLB of Atlanta stock.
(3)  Represents net interest income divided by the average balance of interest-
     earning assets.

                                       41
RATE/VOLUME ANALYSIS

     The table below sets forth certain information regarding changes in our
interest income and interest expense for the periods indicated. For each
category of interest-earning asset and interest-bearing liability, information
is provided on changes attributable to: (i) changes in volume (changes in volume
multiplied by old rate); (ii) changes in rates (change in rate multiplied by old
volume); (iii) changes in rate-volume (changes in rate multiplied by the changes
in volume); and (iv) total change (the sum of the previous columns).
Year Ended September 30,
                                     --------------------------------------------------------------------------
                                       1998           vs.          1997      1997          vs.         1996
                                     ------------------------------------  ------------------------------------
                                              Increase (Decrease)                  Increase (Decrease)
                                                   Due to                               Due to
                                     ------------------------------------  ------------------------------------
                                                        Rate/                                  Rate/
                                     Volume    Rate    Volume     Total     Volume     Rate   Volume      Total
                                     -------  -------  -------    -----     ------     -----  -------     -----
                                                                        (In thousands)
Interest income:
  Loans receivable (1).............  $1,109    $ (85)   $  (6)    $1,018     $1,304   $ 223     $ 20      $1,547
  Investment securities (2)........    (207)     (33)       3       (237)        79      74        2         155
  Other interest-earning assets....     788       23       55        866        (28)     (9)       1         (36)
                                     ------    -----    -----     ------     ------   -----     ----      ------
    Total interest-earning assets..   1,690      (95)      52      1,647      1,355     288       23       1,666
                                     ------    -----    -----     ------     ------   -----     ----      ------
                                                                                                          
Interest expense:                                                                                         
  Deposits.........................     400      181        7        588        593    (282)     (18)        293
  FHLB advances....................     703       (1)     (18)       684         16       6       31          53
                                     ------    -----    -----     ------     ------   -----     ----      ------
     Total interest-bearing                                                                               
         liabilities...............   1,103      180      (11)     1,272        609    (276)      13         346
                                     ------    -----    -----     ------     ------   -----     ----      ------
Change in net interest income......  $  587    $(275)   $  63     $  375     $  746   $ 564     $ 10      $1,320
                                     ======    =====    =====     ======     ======   =====     ====      ======
_______________
(1)    Includes nonaccrual loans and loans held for sale.
(2)    Includes FHLB of Atlanta stock.

COMPARISON OF FINANCIAL CONDITION OF SEPTEMBER 30, 1998 AND 1997

     Total assets increased by $29.7 million, or 11.5%, from $258.5 million at
September 30, 1997 to $288.2 million at September 30, 1998. A significant
portion of the increase in assets was attributable to an increase in cash and
cash equivalents, which increased by $16.1 million, or 107.3%, from $15.0
million at September 30, 1997 to $31.1 million at September 30, 1998. Cash and
cash equivalents consist of cash and interest-bearing deposits in other banks
and are our most liquid assets. We increased our liquidity at September 30, 1998
due to: (i) increased loan sales and prepayments of loans in connection with
refinancings as a result of declining interest rates during the year ended
September 30, 1998; (ii) our retention of cash from a $20.0 million FHLB of
Atlanta advance; and (iii) an increase in deposits while loans receivable
remained stable.

     As a result of historically low prevailing interest rates during the year
ended September 30, 1998, we have increased our mortgage banking activities by
classifying as held for sale substantially all newly originated long-term, 
fixed-rate single-family residential mortgage loans. As a result, our loans held
for sale increased from $684,000 at September 30, 1997 to $7.5 million at
September 30, 1998. In addition, our loans receivable, net decreased by
$340,000, or .2%, from $197.1 million at September 30, 1997 to $196.8 million at
September 30, 1998. While single-family residential mortgage loans decreased by
$7.5 million, or 6.9%, from $108.4 million at September 30, 1997 to $100.9
million at September 30, 1998, we were able to increase our portfolio

                                       42
of construction loans by $6.0 million, or 47.6%, from $12.6 million at September
30, 1997 to $18.6 million at September 30, 1998. The increase in our portfolio
of construction loans reflects our success in obtaining several acquisition and
development loans and loans to builders to build unsold residences, as well as
to an increase in the average size of loans to individuals to build their
primary residences.

     Our investment securities held to maturity increased by $6.7 million, or
28.6%, from $23.5 million at September 30, 1997 to $30.2 million at September
30, 1998, as we used excess liquidity to purchase investment securities.

     During the year ended September 30, 1998, we funded our asset growth
partly with increased deposit accounts but primarily with FHLB of Atlanta
advances. In February 1998, we obtained $20.0 million in FHLB of Atlanta
advances. These advances were structured with maturities estimated to coincide
with the expected repricing of approximately $20.0 million of our loans. See "--
Asset/Liability Management." As a result, FHLB of Atlanta advances totaled $20.0
million at September 30, 1998, as compared to $1.0 million at September 30,
1997. Deposit accounts increased by $6.4 million, or 2.8%, from $229.3 million
at September 30, 1997 to $235.7 million at September 30, 1998. Of the increase,
$5.1 million was attributable to an increase in the transaction accounts, which
we have been promoting during the year. In addition, we have had some success in
cross-selling checking accounts and money market accounts to our commercial
borrowers.

COMPARISON OF OPERATING RESULTS FOR THE YEARS ENDED SEPTEMBER 30, 1998 AND 1997

     Net Income.  We had $2.5 million of net income for each of the years
ended September 30, 1998 and 1997. During the year ended September 30, 1998,
increases in net interest income and other income were offset by increases in
the provision for loan losses and operating expenses. We are establishing a
charitable foundation in connection with the Stock Conversion and contributing
up to 150,000 shares of common stock to the Foundation. The contribution to the
Foundation will reduce our earnings in 1999, the fiscal year in which the
Foundation is to be established and the contribution made, by up to $2.0
million. If the Foundation had been established and the contribution made during
the year ended September 30, 1998, we would have reported net income of
approximately $541,000 rather than reporting net income of approximately $2.5
million, for the year ended September 30, 1998.

     Net Interest Income.   Net interest income was $9.6 million for the year
ended September 30, 1998, as compared to $9.3 million for the year ended
September 30, 1997, representing an increase of $375,000, or 4.1%. During the
year ended September 30, 1998, we were able to increase our net interest income
by leveraging our capital and increasing our levels of interest-earning assets
and interest-bearing liabilities. The average balance of interest-earning assets
increased by $23.9 million, or 10.3%, from $231.6 million for the year ended
September 30, 1997 to $255.6 million for the year ended September 30, 1998
primarily due to increases in the average balances of loans receivable and
interest-bearing overnight deposits. In addition, the average balance of
interest-bearing liabilities increased by $21.4 million, or 9.9%, from $216.5
million for the year ended September 30, 1997 to $237.9 million for the year
ended September 30, 1998 primarily due to increases in the average balances of
deposits and FHLB advances. The effect of the increases in the average balances
of assets and liabilities was offset in part by a decrease in our interest rate
spread from 3.70% for the year ended September 30, 1997 to 3.45% for year ended
September 30, 1998. In February 1998, we obtained $20.0 million in fixed-rate
FHLB of Atlanta advances. These advances were structured with maturities
estimated to coincide with the expected repricing of approximately $20.0 million
of our loans. Through this strategy, we were able to establish a positive
interest rate spread on the $20.0 million of assets and FHLB of Atlanta
advances. The proceeds of advances increased our cash and cash equivalents
pending deployment of the proceeds into loans. Since the time the advances were
obtained interest rates have declined, with the result that our cost of funds
has been negatively affected because the advances have a higher rate of interest
than other sources of funds while cash and cash equivalents have a lower yield
than our other interest-earning assets. As a result, we have been, and currently
are, earning a lesser interest rate spread than we would otherwise be earning
had we not obtained the advances. However, the strategy of obtaining FHLB
advances with maturities matched to a comparably sized portfolio of interest-
earning assets has helped us to significantly reduce our interest rate risk in
times of rising interest rates with respect to that

                                       43
portion of our assets and liabilities. See "--Asset/Liability Management."
However, during the year ended September 30, 1998, we continued our efforts to
increase the yield on interest-earning assets by increasing originations of
loans that are based on the prime rate, such as commercial loans and home equity
lines of credit, and to lower our cost of funds by successfully attracting lower
cost deposits such as checking accounts and money market accounts.

     Interest Income.  Total interest income was $20.7 million for the year
ended September 30, 1998, as compared to $19.1 million for the year ended
September 30, 1997, representing an increase of $1.6 million, or 8.6%. Such
increase was due primarily to a $23.9 million, or 10.3%, increase in the average
balance of the interest-earning assets during such year and, offset in part by a
13 basis point decrease in the average yield on interest-earning assets.

     Interest on loans receivable increased by $1.0 million, or 6.3%, from
$16.2 million for the year ended September 30, 1997 to $17.2 million of the year
ended September 30, 1998. The increase was due primarily to an increase of $12.8
million, or 6.9%, in the average balance of loans receivable from $186.4 million
for the year ended September 30, 1997 to $199.2 million for the year ended
September 30, 1998, reflecting increased single-family residential mortgage loan
and commercial loan originations. The increase in the average balance of loans
receivable more than offset a 4 basis point decrease in the average yield on
loans receivable due to falling market interest rates during the year ended
September 30, 1998. Offsetting the decreased yield attributable to declining
market interest rates were our increased originations of commercial loans and
construction loans, which carry interest rates based on the prime rate, enabling
us earn a higher yield on interest-earning assets, as commercial loans generally
earn higher interest rates than single-family residential mortgage loans,
although those loans entail greater credit risk. See "Business of 1st State 
Bank --Lending Activities --Commercial Lending."

     Interest on investment securities decreased by $237,000, or 9.3%, from
$2.6 million for the year ended September 30, 1997 to $2.3 million for the year
ended September 30, 1998. The decrease was attributable to a $3.2 million, or
8.1%, decrease in the average balance of investment securities from $39.1
million for the year ended September 30, 1997 to $35.9 million for the year
ended September 30, 1998, combined with an 8 basis point decrease in the average
yield on investment securities. As market interest rates fell during the year
ended September 30, 1998, a higher than normal level of our investment
securities were called by the issuers.

     Interest on interest-bearing overnight deposits increased by $867,000
from $336,000 for the year ended September 30, 1997 to $1.2 million for the year
ended September 30, 1998. The increase was due primarily to a $14.3 million
increase in the average balance of other interest-earning assets from $6.1
million for the year ended September 30, 1997 to $20.4 million for the year
ended September 30, 1998, as a result of the $20.0 million of FHLB of Atlanta
advances obtained in February 1998, as well as to a 38 basis point increase in
the yield on other interest-earning assets.

     Interest Expense. During the years ended September 30, 1997 and 1998,
interest expense consisted primarily of interest on deposit accounts. Interest
on deposit accounts increased by $588,000, or 6.0%, from $9.7 million for the
year ended September 30, 1997 to $10.3 million for the year ended September 30,
1998. The increase was due to an $8.8 million, or 4.1%, increase in the average
balance of deposits from $215.5 million for the year ended September 30, 1997 to
$224.3 million for the year ended September 30, 1998. In addition, there was a 9
basis point increase in the average cost of deposits. The increase in the
average cost of deposits reflected our decision to increase our deposit rates to
match competition in our market. In addition, during the year ended September
30, 1998, we had interest expense of $740,000 on our increased balance of FHLB
of Atlanta advances, as compared to $56,000 of interest expense during the year
ended September 30, 1997.

     Provisions for Loan Losses.  Provisions for loan losses are charged to
earnings to maintain the total allowance for loan losses at a level considered
adequate by management to provide for probable loan losses, based on prior loss
experience, volume and type of lending we conduct, industry standards and past
due loans in our loan portfolio. Our policies require the review of assets on a
regular basis, and we appropriately classify loans as well as other assets if
warranted. See "Business of 1st State Bank -- Lending Activities --
Nonperforming Loans and Other Problem Assets" and " -- Allowance for Loan
Losses." We believe we use the best information available to make a
determination with

                                       44
respect to the allowance for loan losses, recognizing that future adjustments
may be necessary depending upon a change in economic conditions. We provided
$477,000 and $261,000 for loan losses during the years ended September 1998 and
1997, respectively. The allowance for loan losses was $3.2 million at September
30, 1998, as compared to $2.8 million at September 30, 1997. The ratio for the
allowance for loan losses to total loans, net of loans in process and deferred
loan fees was 1.61% and 1.38% at September 30, 1998 and 1997, respectively. The
increased provision during the year ended September 30, 1998 reflects the
increased risk in our loan portfolio attributable to the higher percentage of
loans invested in commercial loans, commercial real estate loans and
construction loans. At September 30, 1998, commercial loans, commercial real
estate loans and construction loans totaled $25.2 million, $38.8 million and
$18.6 million, respectively, which amounted to 12.2%, 18.8% and 9.0%,
respectively, of the gross loan portfolio. Comparatively, at September 30, 1997,
commercial loans, commercial real estate loans and construction loans totaled
$22.9 million, $34.3 million and $12.6 million, respectively, which amounted to
11.3%, 17.0% and 6.2%, respectively, of the gross loan portfolio. Single-family
residential real estate loans totaled $100.9 million and $108.4 million at
September 30, 1998 and 1997, respectively, which represented 48.8% and 53.8%,
respectively, of the gross loan portfolio at such dates.

     In addition, changes in the economy during fiscal year 1998 have altered
 the credit risk profile of some of our customers and as a result, we increased
 our provision to reflect this additional credit risk.
 
     Other Income.  Total other income was $1.5 million for the years ended
September 30, 1998 and 1997. During the year ended September 30, 1998, mortgage
banking income, net increased by $256,000. As interest rates decreased during
the year, we decided to sell a greater volume of new residential mortgage loan
originations to reduce our exposure to interest rate risk, thereby generating
increased mortgage banking income. In addition, during the year ended September
30, 1998, commissions from sales of annuities and mutual funds increased by
$38,000 as customers shifted retirement funds into non-insured investments.
Also, customer service fees on loan and deposit accounts increased by $65,000,
or 13.1%, from $500,000 for the year ended September 30, 1997 to $566,000 for
the year ended September 30, 1998 as a result of increased levels of deposit and
loan accounts. Offsetting these increases was a $269,000 securities loss during
the year ended September 30, 1998 from an other than temporary decline in the
value of marketable equity securities. During the mid 1980s, we made an
investment in a mutual fund which invests in mortgage-backed securities and U.S.
Government and agency securities. This investment is classified as available for
sale, and in prior years we have reflected a net unrealized loss on investment
securities on our consolidated balance sheets attributable to the then current
unrealized loss associated with this mutual fund investment. During the year
ended September 30, 1998, we determined that the value of the investment in
marketable equity securities would not recover in the foreseeable future and we
recognized an expense attributable to the other than temporary decline in fair
value. The fair value of marketable equity securities depends largely on changes
in interest rates as the underlying securities are debt securities. To the
extent that there are future changes in interest rates there could be additional
declines in value that are other than temporary.

     Operating Expenses.  Total operating expenses increased by $302,000, or
4.7%, from $6.5 million for the year ended September 30, 1997 to $6.8 million
for the year ended September 30, 1998. Compensation and related benefits
increased by $267,000, or 6.2%, from $4.3 million for the year ended September
30, 1997 to $4.6 million for the year ended September 30, 1998, due to an
increase in expense attributable to normal salary increases and increases in the
number of employees. During the year ended September 30, 1998 and 1997, we
incurred $987,000 and $1.1 million, respectively, in compensation and related
expenses attributable to the implementation and vesting of a Deferred
Compensation Plan for directors and executive officers. The expense associated
with that plan is expected to approximate $200,000 annually beginning with the
year ended September 30, 1999. Occupancy and equipment expenses increased by
$105,000, or 11.1%, from $940,000 for the year ended September 30, 1997 to $1.0
million for the year ended September 30, 1998 due to an $85,000 write-down of
obsolete equipment. Deposit insurance premiums increased by $38,000, or 36.9%,
from $104,000 for the year ended September 30, 1997 to $142,000 for the year
ended September 30, 1998 due to increased levels of deposits. Our operating
expenses will increase in the future due to added expense associated with our
employee stock ownership plan and, later on, our restricted stock plan, as well
as with the costs of being a public company.

                                       45
Income Taxes.  Our income tax expense was $1.4 million for each of the
years ended September 30, 1998 and 1997.  Our effective tax rate was 35.1% for
the year ended September 30, 1998 and 36.2% for the year ended September 30,
1997.

COMPARISON OF OPERATING RESULTS FOR THE YEARS ENDED SEPTEMBER 30, 1997 AND 1996

     Net Income.  We had $2.5 million of net income for the year ended
September 30, 1997, compared to $1.6 million of net income for the year ended
September 30, 1996, representing an increase of $952,000, or 59.7%. The
principal reason for the increase was a $1.3 million increase in net interest
income.

     Net Interest Income.   Net interest income was $9.3 million for the year
ended September 30, 1997, as compared to $7.9 million for the year ended
September 30, 1996, representing an increase of $1.3 million, or 16.6%. The
increase was due to an increase in our interest rate spread from 3.41% for the
year ended September 30, 1996 to 3.70% for year ended September 30, 1997. During
the year ended September 30, 1997, we were able to increase the yield on
interest-earning assets by increasing loans that are based on the prime rate,
such as commercial loans and home equity lines of credit. Concurrently, we were
able to lower our cost of funds by increasing lower cost deposits such as
checking accounts and money market accounts. During the year ended September 30,
1997, we were able to increase our net interest income by leveraging our capital
and increasing our levels of interest-earning assets and interest-bearing
liabilities. The average balance of interest-earning assets increased by $16.0
million, or 7.4%, from $215.6 million for the year ended September 30, 1996 to
$231.6 million for the year ended September 30, 1997 primarily due to increases
in the average balance of loans receivable. In addition, the average balance of
interest-bearing liabilities increased by $13.6 million, or 6.7%, from $202.9
million for the year ended September 30, 1996 to $216.5 million for the year
ended September 30, 1997 primarily due to increases in the average balance of
deposits.

     Interest Income.  Total interest income was $19.1 million for the year
ended September 30, 1997, as compared to $17.4 million for the year ended
September 30, 1996, representing an increase of $1.7 million, or 9.6%. Such
increase was due primarily to a $16.0 million, or 7.4%, increase in the average
balance of the interest-earning assets during such year and, to a lesser extent,
to a 16 basis point increase in the average yield on interest-earning assets.

     Interest on loans receivable increased by $1.5 million, or 10.6%, from
$14.6 million for the year ended September 30, 1996 to $16.2 million of the year
ended September 30, 1997. The increase was due primarily to an increase of $15.3
million, or 8.9%, in the average balance of loans receivable from $171.1 million
for the year ended September 30, 1996 to $186.4 million for the year ended
September 30, 1997, reflecting increased single-family residential mortgage loan
and commercial loan originations. The increase in interest on loans receivable
also reflected a 13 basis point increase in the average yield on loans
receivable. By increasing originations of commercial loans and home equity lines
of credit that carry interest rates based on the prime rate, we were able to
increase our average yield on interest-earning assets, as commercial loans
generally earn higher interest rates than single-family residential mortgage
loans, although those loans entail greater credit risk. See "Business of 1st
State Bank -- Lending Activities -- Commercial Lending."

     Interest on investment securities increased by $156,000, or 6.5%, from
$2.4 million for the year ended September 30, 1996 to $2.6 million for the year
ended September 30, 1997. The increase was attributable to a $1.2 million, or
3.3%, increase in the average balance of investment securities from $37.9
million for the year ended September 30, 1996 to $39.1 million for the year
ended September 30, 1997, as well as to a 19 basis point increase in the average
yield on investment securities. As market interest rates were rising during the
year ended September 30, 1997, we invested excess liquidity in short-term U.S.
government and agency securities to increase our yield on interest-earning
assets.

     Interest Expense. During the years ended September 30, 1996 and 1997,
interest expense consisted almost entirely of interest on deposit accounts.
Interest on deposit accounts increased by $293,000, or 3.1%, from $9.5 million
for the year ended September 30, 1996 to $9.7 million for the year ended
September 30, 1997. The increase was due

                                       46
to a $12.7 million, or 6.3%, increase in the average balance of deposits from
$202.8 million for the year ended September 30, 1996 to $215.5 million for the
year ended September 30, 1997. The increase in the average balance of deposits
more than offset a 14 basis point decrease in the average cost of deposits. The
decrease in the average cost of deposits reflected the increase in the
percentage of our deposits comprised of lower cost deposits such as checking
accounts and money market accounts.

       Provisions for Loan Losses. We provided $261,000 and $281,000 for loan
losses during the years ended September 1997 and 1996, respectively. The
allowance for loan losses was $2.8 million at September 30, 1997, as compared to
$2.5 million at September 30, 1996. The ratio for the allowance for loan losses
to total loans, net of loans in process and deferred loan fees was 1.38% at
September 30, 1997 and 1.42% at September 30, 1996.
 
       Other Income. Total other income increased by $289,000 , or 24.5%, from
$1.2 million for the year ended September 30, 1996 to $1.5 million for the year
ended September 30, 1997. Of such increase, $113,000 was attributable to
increased commissions from sales of annuities and mutual funds, as customers
shifted retirement funds into noninsured investments, and $77,000 was
attributable to an increase in mortgage banking income, net. Also contributing
to the increase in other income was a $88,000, or 21.4%, increase in customer
service fees on loan and deposit accounts, which increased from $412,000 for the
year ended September 30, 1996 to $500,000 for the year ended September 30, 1997
as a result of increased levels of loan and deposit accounts.

       Operating Expenses. Total operating expenses increased by $69,000, or
1.1%, from $6.4 million for the year ended September 30, 1996 to $6.5 million
for the year ended September 30, 1997. Compensation and related benefits
increased by $1.4 million, or 47.3%, from $2.9 million for the year ended
September 30, 1996 to $4.3 million for the year ended September 30, 1997, due to
an increase in expense attributable to the implementation and vesting of a
Deferred Compensation Plan for directors and executive officers. The increase in
compensation and related benefits offset a decrease in operating expenses as a
result of a $1.3 million expense incurred during the year ended September 30,
1996 as a result of a special assessment by the FDIC to recapitalize the SAIF.
During the year ended September 30, 1996, we paid a one-time special assessment
in the amount of $1.3 million assessed by the FDIC on all SAIF-insured
institutions to capitalize the SAIF insurance fund of the FDIC up to required
reserved ratio. Prior to such special assessment, we paid continuing SAIF
insurance premiums at the rate of 23 cents per $100 of SAIF deposits. However,
the rate dropped to 6.4 cents per $100 effective January 1, 1997 through
September 30, 1999 and, based on our current condition, will further decrease to
2.4 cents per $100 thereafter. This revised deposit insurance rate structure
enabled us to recognize the substantial reduction in deposit insurance premiums
during the year ended September 30, 1997. Deposit insurance premiums decreased
from $465,000 for the year ended September 30, 1996 to $104,000 for the year
ended September 30, 1997.

       Income Taxes. Our income tax expense was $841,000 and $1.4 million for
the years ended September 30, 1996 and 1997, respectively. Our effective tax
rate was 34.5% for the year ended September 30, 1996 and 36.2% for the year
ended September 30, 1997.

IMPACT OF INFLATION AND CHANGING PRICES

       Our financial statements and the accompanying notes presented elsewhere
in this document, have been prepared in accordance with generally accepted
accounting principles, which require the measurement of financial position and
operating results in terms of historical dollars without considering the change
in the relative purchasing power of money over time and due to inflation. The
impact of inflation is reflected in the increased cost of our operations. As a
result, interest rates have a greater impact on our performance than do the
effects of general levels of inflation. Interest rates do not necessarily move
in the same direction or to the same extent as the prices of goods and services.

                                       47
IMPACT OF NEW ACCOUNTING STANDARDS

       Reporting Comprehensive Income. In June 1997, the FASB issued Statement
of Financial Accounting Standards No. 130 ("SFAS 130"), "Reporting Comprehensive
Income." SFAS 130 establishes standards for reporting and displaying
comprehensive income and its components (revenues, expenses, gains, and losses)
in a full set of general-purpose financial statements. This Statement requires
that an enterprise (a) classify items of other comprehensive income by their
nature in the financial statement and (b) display the accumulated balance of
other comprehensive income separately from retained earnings and additional 
paid-in-capital in the equity section of a statement of financial position. SFAS
130 is effective for fiscal years beginning after December 15, 1997.
Reclassification of financial statements for earlier periods provided for
comparative purposes is required. We adopted SFAS 130 on October 1, 1998. Other
comprehensive income consists of unrealized gains and losses on certain
investment securities and would have been $167,000 at September 30, 1998. Total
comprehensive income would have been $2.7 million at September 30, 1998.

       Disclosures Regarding Segments. In June 1997, the FASB issued Statement
of Financial Accounting Standards No. 131 ("SFAS 131"), "Disclosures about
Segments of an Enterprise and Related Information." SFAS 131 establishes
standards for the way that public businesses report information about operating
segments in annual financial statements and requires that those enterprises
report selected information about operating segments in interim financial
reports issued to shareholders. It also establishes standards for related
disclosures about products and services, geographic areas, and major customers.
This Statement is effective for financial statements for periods beginning after
December 15, 1997 and in the initial year of application, comparative
information for earlier years is to be restated. We adopted SFAS 131 on October
1, 1998 without any significant impact on our consolidated financial statements
as we operate as one segment.

       Employers Disclosures About Pensions and Other Postretirement Benefits.
In February 1998, the FASB issued SFAS No. 132, "Employers Disclosures About
Pension and Other Postretirement Benefits," which standardizes disclosure
requirements for pensions and postretirement benefits. This Statement is
effective for fiscal years beginning after December 15, 1997. We do not believe
that the adoption of SFAS No. 132 will have a material effect on our
consolidated financial statements because we do not have a pension plan or other
postretirement benefits.

       Accounting for Derivative Instruments and Hedging Activities. In June
1998, the FASB issued SFAS No. 133. This Statement standardizes the accounting
for derivative instruments including certain derivative instruments embedded in
other contracts, by requiring that an entity recognize these items as assets or
liabilities in the statement of financial position and measure them at fair
value. This Statement generally provides for matching the timing of gain or loss
recognition on the hedging instrument with the recognition of the changes in the
fair value of the hedged asset or liability that are attributable to the hedged
risk or the earnings effect of the hedged forecasted transaction. The Statement,
which is effective for all fiscal quarters of all fiscal years beginning after
June 15, 1999, will not affect our financial position or our results of
operations because we do not have or intend to have derivative financial
instruments.

                      BUSINESS OF 1ST STATE BANCORP, INC.

       We organized the Company in November 1998 for the purpose of becoming a
holding company to own all of the Bank's outstanding capital stock. The Company
currently is not an operating company. Following the Conversion, the Company
will be engaged primarily in the business of directing, planning and
coordinating the business activities of the Converted Bank. In the future, the
Company may become an operating company or acquire or organize other operating
subsidiaries, including other financial institutions, though we have no current
plans in this regard. Initially, the Company will not maintain offices separate
from those of the Bank nor employ any persons other than its officers who will
not be separately compensated for such service.

                                       48
BUSINESS OF 1ST STATE BANK

GENERAL

       Our principal business consists of attracting deposits from the general
public and investing these funds in loans secured by single-family residential
and commercial real estate, secured and unsecured commercial loans and consumer
loans. We derive our income principally from interest earned on loans and
investments and, to a lesser extent, miscellaneous fees relating to our loans
and deposits, mortgage banking income and commissions from annuity and mutual
fund sales. Our principal expenses are interest expense on deposits and
borrowings and other expense such as compensation and related benefits,
occupancy and equipment expenses and other miscellaneous expenses. Funds for
these activities are provided principally by deposits, borrowings, repayments of
outstanding loans and investments and operating revenues.

MARKET AREA

       Our market area is Alamance County in north central North Carolina,
located on the Interstate 85 corridor between the Piedmont Triad and Research
Triangle. We estimate that more than 90% of deposits and loans come from our
market area.

       Historically, the economy of our market area has been heavily dependent
on the textile industry. During the past 20 years, the economy in Alamance
County has diversified to some extent, with increasing employment in the areas
of insurance, banking, manufacturing and services. Major employers in the area
include LabCorp, Burlington Industries, Alamance County Schools, Glenraven Mills
and Alamance Health Services. Nevertheless, the economy in Alamance County
continues to be heavily dependent on the textile industry.

                                       49
LENDING ACTIVITIES

       Loan Portfolio Composition. At September 30, 1998, our gross loan
portfolio totaled $206.6 million and represented 71.7% of total assets. The
following table sets forth information relating to the composition of our loan
portfolio by type of loan at the dates indicated. At September 30, 1998, we had
no concentrations of loans exceeding 10% of gross loans other than as disclosed
below. Excluded from this table are mortgage loans held for sale which are
presented separately on our consolidated balance sheets and in "Selected
Consolidated Financial Information and Other Data."
AT SEPTEMBER 30,
                                                                     -------------------------
                                              1998                1997             1996               1995               1994
                                        -----------------     --------------   ---------------    -------------      --------------
                                        AMOUNT       %         AMOUNT    %      AMOUNT    %       AMOUNT     %        AMOUNT     % 
                                        ------      ---        ------   ---     ------   ---      ------    ---       ------    ---
                                                                        (DOLLARS IN THOUSANDS)
Real estate loans:
  Single-family residential........... $100,891    48.84%    $108,400   53.76% $100,247   55.70% $ 98,660   55.78% $ 91,094   57.51%
  Commercial..........................   38,763    18.76       34,333   17.02    35,302   19.62    35,774   20.23    29,922   18.89
  Home equity.........................   16,877     8.17       18,141    8.99    15,872    8.82    16,409    9.28    15,326    9.67
  Construction........................   18,572     8.99       12,582    6.24     7,838    4.36     7,084    4.01     5,675    3.58
                                       --------   ------     --------  ------  --------  ------  --------  ------  --------  ------ 
      Total real estate...............  175,103    84.76      173,456   86.01   159,259   88.50   157,927   89.30   142,017   89.65
  Commercial..........................   25,190    12.19       22,870   11.34    16,989    9.44    15,072    8.52    12,876    8.13
  Consumer............................    6,310     3.05        5,354    2.65     3,706    2.06     3,847    2.18     3,514    2.22
                                       --------   ------     --------  ------  --------  ------  --------  ------  -------- ------- 
                                        206,603   100.00%     201,680  100.00%  179,954  100.00%  176,846  100.00%  158,407  100.00%
                                       --------   ======     --------  ======  --------  ======   -------  ======  --------  ======
Less:
  Loans in process....................   (6,446)               (1,660)           (3,515)           (3,457)           (2,446)
  Deferred fees and discounts.........     (147)                 (144)              (94)              (73)                1
  Allowance for loan losses...........   (3,228)               (2,754)           (2,496)           (2,223)           (1,767)
                                       --------              --------          --------          --------          --------  
      Total........................... $196,782              $197,122          $173,849          $171,093          $154,195
                                       ========              ========          ========          ========          ========
50
LOAN MATURITY SCHEDULE

       The following table sets forth certain information at September 30, 1998
regarding the dollar amount of loans maturing in our portfolio based on their
contractual terms to maturity, including scheduled repayments of principal.
Demand loans, loans having no stated schedule of repayments, such as lines of
credit, and overdrafts are reported as due in one year or less. The table does
not include any estimate of prepayments which significantly shorten the average
life of mortgage loans and may cause our repayment experience to differ from
that shown below.
DUE AFTER        DUE AFTER        DUE AFTER
                                                           3 THROUGH        5 THROUGH        10 THROUGH       DUE AFTER 15
                           DUE DURING THE YEAR ENDING     5 YEARS AFTER   10 YEARS AFTER    15 YEARS AFTER     YEARS AFTER
                                 SEPTEMBER 30,            SEPTEMBER 30,    SEPTEMBER 30,     SEPTEMBER 30,    SEPTEMBER 30,     
                           ---------------------------                            
                           1999      2000      2001           1998            1998              1998              1998       TOTAL 
                           ------   ------  ----------    ------------    --------------    ------------      ------------   ------
                                                                      (IN THOUSANDS)
Real estate loans:
  Single-family........... $ 3,140   $3,321    $ 1,530     $ 5,887        $12,368           $15,753           $58,892       $100,891
  Commercial..............   3,020    1,581      1,851      15,314          7,028             7,431             2,538         38,763
  Home equity.............     309       29         54         396          5,083            11,006                --         16,877
  Construction............   8,605    1,390      1,758         373             --                --                --         12,126
Commercial................  12,181    2,495      4,236       4,727            790               761                --         25,190
Consumer..................   2,024      690      1,347       2,056            193                --                --          6,310
                            -------  ------    -------     -------        -------           -------           --------      --------
     Total................ $29,279   $9,506    $10,776     $28,753        $25,462           $34,951           $61,430       $200,157
                           =======   ======    =======     =======        =======           =======           ========      ========
The following table sets forth at September 30, 1998, the dollar amount of all
loans due one year or more after September 30, 1998 which have predetermined
interest rates and have floating or adjustable interest rates.
PREDETERMINED         FLOATING OR
                                                       RATE            ADJUSTABLE RATES          TOTAL
                                                    -------------      ----------------          ------
                                                                       (IN THOUSANDS)
Real estate loans:
           Single-family residential......          $   66,846         $    30,905           $    97,751
           Commercial.....................              22,485              13,258                35,743 
           Home equity....................               2,811              13,757                16,568 
           Construction...................                 569               2,952                 3,521 
        Commercial.....................                  4,199               8,810                13,009 
        Consumer.......................                  4,205                  81                 4,286  
                                                    ----------         -----------           -----------
              Total.......................          $  101,115         $    69,763           $   170,878
                                                    ==========         ===========           ===========
51
Scheduled contractual principal repayments of loans do not reflect the
actual life of the loans. The average life of loans can be substantially less
than their contractual terms because of prepayments. In addition, due-on-sale
clauses on loans generally give us the right to declare a loan immediately due
and payable in the event that, among other things, the borrower sells the real
property subject to the mortgage and the loan is not repaid. The average life of
mortgage loans tends to increase when current mortgage loan market rates are
substantially higher than rates on existing mortgage loans and, conversely,
decrease when current mortgage loan market rates are substantially lower than
rates on existing mortgage loans.

       Originations, Purchases and Sales of Loans. We generally have authority
to originate and purchase loans secured by real estate located throughout the
United States. Consistent with our emphasis on being a community-oriented
financial institution, we concentrate our lending activities in our market area.

       The following table sets forth certain information with respect to our
loan origination, purchase and sale activity for the periods indicated.
YEAR ENDED SEPTEMBER 30,       
                                     ---------------------------------------
                                       1998           1997            1996    
                                     --------       ---------       --------  
                                                (IN THOUSANDS) 30
Loans originated:                                                           
    Real estate loans:                                                        
      Single-family residential..    $ 44,118      $ 27,731         $ 20,517  
      Commercial.................       9,437         5,446            9,536  
      Home equity................       7,351         6,340            5,083  
      Construction...............      19,158        17,082           12,912  
                                     --------       -------          -------  
       Total real estate loans...      80,064        56,599           48,048  
    Commercial...................      18,982        15,835           11,210  
    Consumer.....................       6,361         6,801            3,670  
                                     --------       -------          -------  
         Total loans originated..    $105,407      $ 79,235         $ 62,928  
                                     ========       =======          =======  
                                                                              
  Loans purchased:                                                            
    Real estate loans............    $    135      $     96         $     15  
    Other loans..................          18            --               --  
                                     --------      --------         --------  
       Total loans purchased.....    $    153      $     96         $     15  
                                     ========      ========         ========  
                                                                              
  Loans sold: (1)................    $ 27,635      $  9,166         $  9,181  
                                     ========      ========         ========
---------------------------
(1) All loans sold were whole loans.

       Our loan originations are derived from a number of sources, including
referrals from depositors and borrowers, repeat customers, advertising and
calling officers, as well as walk-in customers. Our solicitation programs
consist of advertisements in local media and participation in various community
organizations and events. Real estate loans are originated by our loan
personnel. All of our loan personnel are salaried and are eligible to receive
commissions for loans originated. We accept loan applications at our offices and
do not originate loans on an indirect basis such as through arrangements with
automobile dealers. In all cases, we have final approval of the application.
Historically, we have purchased limited quantities of loans. During the years
ended September 30, 1998, 1997 and 1996, virtually all loans purchased were
small participation interests in multi-family residential real estate loans to
finance low income housing.

       In recent years, and particularly during the year ended September 30,
1998, we have sold an increasing amount of fixed-rate, single-family mortgage
loans that we originated. During the years ended September 30, 1998, 1997 and
1996, we sold $27.6 million, $9.2 million and $9.2 million, respectively, of
such loans. Typically, in the current low interest rate environment, we have
been selling fixed-rate, single-family mortgage loans with terms of 15 years or
more 

                                       52
except in cases where the interest rate is sufficient to compensate us for the
risk of retaining a long-term, fixed-rate loan in our portfolio. Most loans have
been sold to private purchasers with servicing released. In addition, a smaller
amount of loans are sold in the secondary market to the FHLMC. We retain
servicing on loans sold to the FHLMC.

       Loan Underwriting Policies. Our lending activities are subject to our
written, non-discriminatory underwriting standards and to loan origination
procedures prescribed by our Board of Directors and management. Detailed loan
applications are obtained to determine the borrower's ability to repay, and the
more significant items on these applications are verified through the use of
credit reports, financial statements and confirmations. Individual officers have
been granted authority by the Board of Directors to approve mortgage, consumer
and commercial loans up to varying specified dollar amounts, depending upon the
type of loan. A loan committee consisting of our President, Executive Vice
President, Chief Financial Officer, senior credit officer and head of mortgage
lending has authority to approve any loan in an amount exceeding individual
lending authorities where our total loans to that borrower would not exceed
$350,000. Our executive committee, which consists of the Chairman of the Board,
the President, two additional Board members that serve on a permanent basis and
one Board member selected on a rotating basis that serves for a three-month
period, has authority to approve any loan where our total loans to that borrower
would not exceed $1.0 million. Loans above that amount may not be made unless
approved by the full Board of Directors. These authorities are based on
aggregate borrowings of an individual or entity. On a monthly basis, the full
Board of Directors reviews the actions taken by the loan committee and the
executive committee.

       Applications for single-family real estate loans are underwritten and
closed in accordance with the standards of FHLMC. Generally, upon receipt of a
loan application from a prospective borrower, a credit report and verifications
are ordered to verify specific information relating to the loan applicant's
employment, income and credit standing. If a proposed loan is to be secured by a
mortgage on real estate, an appraisal of the real estate is usually undertaken
by an appraiser approved by us and licensed by the State of North Carolina.
Except when we become aware of a particular risk of environmental contamination,
we generally do not obtain a formal environmental report on real estate at the
time a loan is made.

       Our policy is to record a lien on the real estate securing a loan and to
obtain title insurance which insures that the property is free of prior
encumbrances and other possible title defects. Borrowers must also obtain hazard
insurance policies prior to closing and, when the property is in a flood plain
as designated by the Department of Housing and Urban Development, pay flood
insurance policy premiums.

       With respect to single-family residential mortgage loans, we make a loan
commitment of between 30 and 60 days for each loan approved. If the borrower
desires a longer commitment, the commitment may be extended for good cause and
upon written approval. The interest rate is guaranteed for the commitment
period.

       We are permitted to lend up to 95% of the lesser of the appraised value
or the purchase price of the real property securing a mortgage loan. However, if
the amount of a residential loan originated or refinanced exceeds 80% of the
appraised value, our policy generally is to obtain private mortgage insurance at
the borrower's expense on that portion of the principal amount of the loan that
exceeds 80% of the appraised value of the property. We will make a single-family
residential mortgage loan with up to a 95% loan-to-value ratio if the required
private mortgage insurance is obtained. We generally limit the loan-to-value
ratio on commercial real estate mortgage loans to 80%, although the loan-to-
value ratio on commercial real estate loans in limited circumstances has been as
high as 85%. We limit the loan-to-value ratio on multi-family residential real
estate loans to 80%.

       Under applicable law, with certain limited exceptions, loans and
extensions of credit by a savings institution to a person outstanding at one
time and not fully secured by collateral having a market value at least equal to
the amount of the loan or extension of credit shall not exceed 15% of net worth
plus the general loan loss reserve. Loans and extensions of credit fully secured
by readily marketable collateral may comprise an additional 10% of net worth.
Applicable law additionally authorizes savings institutions to make loans to one
borrower, for any purpose: (i) in an amount not to exceed $500,000; (ii) in an
amount not to exceed the lesser of $30,000,000 or 30% of net worth to

                                       53
develop residential housing, provided (a) the purchase price of each single-
family dwelling in the development does not exceed $500,000 and (b) the
aggregate amount of loans made under this authority does not exceed 150% of net
worth; or (iii) loans to finance the sale of real property in satisfaction of
debts previously contracted in good faith, not to exceed 50% of net worth. Under
these limits, our loans to one borrower were limited to $4.4 million at
September 30, 1998. At that date, we had no lending relationships in excess of
the loans-to-one-borrower limit. At September 30, 1998, our ten largest lending
relationships ranged in size from $2.4 million to $4.3 million.

       Single-Family Residential Real Estate Lending. We historically have been
and continue to be an originator of single-family, residential real estate loans
in our market area. At September 30, 1998, single-family, residential mortgage
loans, excluding home equity loans, totaled $100.9 million, or 48.8% of our
gross loan portfolio.

       We originate fixed-rate mortgage loans at competitive interest rates. At
September 30, 1998, $68.8 million, or 33.3%, of our gross loan portfolio was
comprised of fixed-rate, single-family mortgage loans. Generally, in the
currently low interest rate environment, we have been retaining fixed-rate
mortgages with maturities of ten years or less while fixed-rate loans with
longer maturities are being sold in the secondary market.

       We also offer adjustable-rate residential mortgage loans. The adjustable-
rate loans we currently offer have interest rates which adjust every one, three
or five years from the closing date of the loan or on an annual basis commencing
after an initial fixed-rate period of three or five years in accordance with a
designated index, plus a stipulated margin. The primary index we utilize is the
weekly average yield on U.S. Treasury securities adjusted to a constant
comparable maturity equal to the loan adjustment period, as made available by
the Federal Reserve Board (the "Treasury Rate"). The maximum adjustment on the
bulk of our loans is 2% per adjustment period with a maximum aggregate
adjustment of 6% over the life of the loan. We offer adjustable-rate mortgage
loans that provide for initial rates of interest slightly below the rates that
would prevail when the index used for repricing is applied, i.e., "teaser"
rates. All of our adjustable-rate loans require that any payment adjustment
resulting from a change in the interest rate of an adjustable-rate loan be
sufficient to result in full amortization of the loan by the end of the loan
term and, thus, do not permit any of the increased payment to be added to the
principal amount of the loan, or so-called negative amortization. At September
30, 1998, $32.1 million, or 31.8%, of our single-family residential mortgage
loans were adjustable-rate loans.

       The retention of adjustable-rate loans in our portfolio helps reduce our
exposure to increases or decreases in prevailing market interest rates. However,
there are unquantifiable credit risks resulting from potential increases in
costs to borrowers in the event of upward repricing of adjustable-rate loans. It
is possible that during periods of rising interest rates, the risk of default on
adjustable-rate loans may increase due to increases in interest costs to
borrowers. Further, although adjustable-rate loans allow us to increase the
sensitivity of our interest-earning assets to changes in interest rates, the
extent of this interest sensitivity is limited by the initial fixed-rate period
before the first adjustment and the lifetime interest rate adjustment
limitations. Accordingly, there can be no assurance that yields on our
adjustable-rate loans will fully adjust to compensate for increases in our cost
of funds.

       Commercial Real Estate Lending. Our commercial real estate loan portfolio
includes loans secured by small office buildings, commercial and industrial
buildings and small apartment buildings. Such loans generally range in size from
$100,000 to $3.3 million. At September 30, 1998, our commercial real estate
loans totaled $38.8 million, which amounted to 18.8%, of our gross loan
portfolio. We originate commercial real estate loans for terms of up to 15 years
and with interest rates that adjust daily based on our prime rate plus a
negotiated margin typically up to 1% or that carry predetermined rates fixed for
one, three or five years.

       Commercial real estate lending entails significant additional risks as
compared with single-family residential property lending. Commercial real estate
loans typically involve larger loan balances to single borrowers or groups of
related borrowers. The payment experience on such loans typically is dependent
on the successful operation of the real estate project, retail establishment,
apartment building or business. These risks can be significantly affected by
supply and demand conditions in the market for office, retail and residential
space, and, as such, may be subject to a greater

                                       54
extent to adverse conditions in the economy generally. To minimize these risks,
we generally originate loans secured by collateral located in our market area or
to borrowers with which we have prior experience or who are otherwise known to
us. It has been our policy to obtain annual financial statements of the business
of the borrower or the project for which commercial real estate loans are made.
In addition, in the case of commercial mortgage loans made to a partnership or a
corporation, we seek, whenever possible, to obtain personal guarantees and
annual financial statements of the principals of the partnership or corporation.

       Home Equity Loans. At September 30, 1998, we had approximately $16.9
million in home equity line of credit loans, representing approximately 8.2% of
our gross loan portfolio. Our home equity lines of credit generally have
adjustable interest rates tied to our prime interest rate plus a margin,
although we currently are offering a program where the interest rate on home
equity loans will be fixed for one or two years. Home equity lines of credit
must be repaid in 15 years or less and require monthly interest payments. Home
equity lines of credit generally are secured by subordinate liens against
residential real property. We require that fire and extended coverage casualty
insurance (and, if appropriate, flood insurance) be maintained in an amount at
least sufficient to cover the loan. Home equity loans generally are limited so
that the amount of such loans, along with any senior indebtedness, does not
exceed 80% of the value of the real estate security.

       Construction Lending. We offer residential and commercial construction
loans, with a significant portion of such loans originated to date being for the
construction of owner-occupied, single-family dwellings in our market area.
Residential construction loans are offered primarily to individuals building
their primary or secondary residence, as well as to selected local developers to
build single-family dwellings. In addition, on occasion, we make acquisition and
development loans to local developers to acquire and develop land for sale to
builders who will construct single-family residences. At September 30, 1998,
$18.6 million, or 9.0%, of our gross loan portfolio consisted of construction
loans.

       Generally, loans to owner/occupants for the construction of owner-
occupied, single-family residential properties are originated in connection with
the permanent loan on the property and have a construction term of six to 12
months. Such loans are offered on an adjustable-rate basis. Interest rates on
residential construction loans made to the owner/occupant have interest rates
during the construction period equal to our prime rate. Upon completion of
construction, the loan is converted into a one-year adjustable-rate loan, and
the owner may lock in a fixed-rate loan at any time during the one-year period.

       We make construction loans to builders on either a pre-sold or
speculative (unsold) basis. However, we limit the number of outstanding loans on
unsold homes under construction to individual builders, with the amount
dependent on the financial strength of the builder, the present exposure of the
builder, the location of the property and prior sales of homes in the
development. At September 30, 1998, speculative construction loans amounted to
$5.8 million. At September 30, 1998, the largest amount of construction loans
outstanding to one builder was $600,000, all of which was for speculative
construction. Interest rates on residential construction loans to builders are
set at our prime rate plus a margin typically up to 1% and adjust with changes
in the prime rate, and are made for terms of up to 24 months.

       Interest rates on commercial construction loans are based on the prime
rate plus a negotiated margin typically up to 1%, and adjust with changes in our
prime rate, and are made for terms of up to 24 months, with construction terms
generally not exceeding 12 months.

       Acquisition and development loans are made at a rate that adjusts
monthly, based on our prime rate plus a negotiated margin, for terms of up to
three years. Interest only is paid during the term of the loan, and the
principal balance of the loan is paid down as developed lots are sold to
builders. See "Risk Factors -- Risks Related to Commercial and Consumer
Lending." At September 30, 1998, we had eight such loans outstanding totaling
$4.1 million. All acquisition and development loans were performing in
accordance with their terms at such date.

       Prior to making a commitment to fund a construction loan, we require an
appraisal of the property by appraisers approved by the Board of Directors. We
also review and inspect each project at the commencement of construction and

                                       55
either weekly or biweekly during the term of the construction loan. We may
charge a construction fee and/or an inspection fee on construction loans.
Advances are made on a percentage of completed basis.

       Construction financing generally is considered to involve a higher degree
of risk of loss than long-term financing on improved, occupied real estate. Risk
of loss on a construction loan is dependent largely upon the accuracy of the
initial estimate of the property's value at completion of construction or
development and the estimated cost (including interest) of construction. During
the construction phase, a number of factors could result in delays and cost
overruns. If the estimate of construction costs proves to be inaccurate and the
borrower is unable to meet our requirements of putting up additional funds to
cover extra costs or change orders, then we will demand that the loan be paid
off and, if necessary, institute foreclosure proceedings, or refinance the loan.
If the estimate of value proves to be inaccurate, we may be confronted, at or
prior to the maturity of the loan, with collateral having a value which is
insufficient to assure full repayment. We have sought to minimize this risk by
limiting construction lending to qualified borrowers (i.e., borrowers who
satisfy all credit requirements and whose loans satisfy all other underwriting
standards which would apply to our permanent mortgage loan financing for the
subject property) in our market area. On loans to builders, we work only with
selected builders with whom we have experience and carefully monitor the
creditworthiness of the builders.

       Commercial Lending. We originate commercial loans to small and medium
sized businesses in our market area. Our commercial borrowers are generally
small businesses engaged in manufacturing, distribution or retailing, or
professionals in healthcare, accounting and law. Commercial loans generally are
made to finance the purchase of inventory, new or used equipment or commercial
vehicles and for short-term working capital. Such loans generally are secured by
equipment and inventory, and, if possible, cross-collateralized by a real estate
mortgage, although commercial loans are sometimes granted on an unsecured basis.
Commercial loans generally are made for terms of five years or less, depending
on the purpose of the loan and the collateral, with loans to finance operating
expenses made for one year or less, with interest rates that adjust at least
annually at a rate equal to our prime rate plus a margin typically up to 2%.
Generally, commercial loans are made in amounts ranging between $50,000 and $1.0
million. At September 30, 1998, commercial loans totaled $25.2 million, or 12.2%
of our gross loan portfolio.

       We underwrite commercial loans on the basis of the borrower's cash flow
and ability to service the debt from earnings rather than on the basis of
underlying collateral value, and we seek to structure such loans to have more
than one source of repayment. The borrower is required to provide us with
sufficient information to allow us to make our lending determination. In most
instances, this information consists of at least two years of financial
statements, a statement of projected cash flows, current financial information
on any guarantor and any additional information on the collateral. For loans
with maturities exceeding one year, we require that borrowers and guarantors
provide updated financial information at least annually throughout the term of
the loan.

       Our commercial loans may be structured as term loans or as lines of
credit. Commercial term loans are generally made to finance the purchase of
assets and have maturities of five years or less. Commercial lines of credit are
typically made for the purpose of providing working capital and are usually
reviewed on an annual basis but may be called on demand. We also offer standby
letters of credit for commercial borrowers. Standby letters of credit are
written for a maximum term of one year.

       Commercial loans are often larger and may involve greater risk than other
types of lending. Because payments on such loans are often dependent on
successful operation of the business involved, repayment of such loans may be
subject to a greater extent to adverse conditions in the economy. We seek to
minimize these risks through our underwriting guidelines, which require that the
loan be supported by adequate cash flow of the borrower, profitability of the
business, collateral and personal guarantees of the individuals in the business.
In addition, we limit this type of lending to our market area and to borrowers
with which we have prior experience or who are otherwise well known to us.

                                       56
Consumer Lending. In recent years, we have gradually increased our
portfolio of consumer loans. Our consumer loans include automobile loans,
savings account loans, unsecured lines of credit and miscellaneous other
consumer loans, including unsecured loans. At September 30, 1998, the Bank's
consumer loans totaled $6.3 million, or 3.1% of our gross loan portfolio.

       Automobile loans are generally underwritten in amounts up to 80% of the
lesser of the purchase price of the automobile or, with respect to used
automobiles, the loan value as published by the National Automobile Dealers
Association. The terms of most such loans do not exceed 72 months. We require
that the vehicles be insured and that we be listed as loss payee on the
insurance policy.

       We make savings account loans for up to 90% of the depositor's savings
account balance. The interest rate is normally 2.5% above the annual percentage
yield paid on the savings account. The account must be pledged as collateral to
secure the loan. Interest generally is paid on a monthly basis.

       Consumer lending affords us the opportunity to earn yields higher than
those obtainable on single-family residential lending. However, consumer loans
entail greater risk than do residential mortgage loans, particularly in the case
of loans which are unsecured (as is the case with lines of credit) or secured by
rapidly depreciable assets such as automobiles. Repossessed collateral for a
defaulted consumer loan may not provide an adequate source of repayment of the
outstanding loan balance as a result of the greater likelihood of damage, loss
or depreciation. The remaining deficiency often does not warrant further
substantial collection efforts against the borrower. In addition, consumer loan
collections are dependent on the borrower's continuing financial stability, and
thus are more likely to be adversely affected by events such as job loss,
divorce, illness or personal bankruptcy. Further, the application of various
state and federal laws, including federal and state bankruptcy and insolvency
law, may limit the amount which may be recovered. In underwriting consumer
loans, we consider the borrower's credit history, an analysis of the borrower's
income and ability to repay the loan, and the value of the collateral.

       Loan Fees and Servicing. We receive fees in connection with late payments
and for miscellaneous services related to our loans and deposits. We also charge
fees in connection with loan originations. These fees can consist of
origination, discount, construction and/or commitment fees, depending on the
type of loan. We generally do not service loans for others except for mortgage
loans we originate and sell with servicing retained. Mortgage servicing rights
were not material for any of the periods presented.

       Nonperforming Loans and Other Problem Assets. We continually monitor our
loan portfolio to anticipate and address potential and actual delinquencies.
When a borrower fails to make a payment on a loan, we take immediate steps to
have the delinquency cured and the loan restored to current status. Loans which
are delinquent more than 15 days incur a late fee of 4% of the monthly payment
of principal and interest due. As a matter of policy, we will contact the
borrower after the loan has been delinquent 15 days. If payment is not promptly
received, the borrower is contacted again, and efforts are made to formulate an
affirmative plan to cure the delinquency. Generally, after any loan is
delinquent 45 days or more, we send a default letter to the borrower. If the
default is not cured after 30 days, we commence formal legal proceedings to
collect amounts owed.

       Generally we charge-off or reserve through an allowance account interest
on loans, including impaired loans, that are contractually ninety days or more
past due. The allowance is established by a charge to interest income equal to
all interest previously accrued. In certain circumstances, interest on loans
that are contractually ninety days or more past due is not charged off or
reserved through an allowance account when we believe that the loan is both well
secured and in the process of collection. If amounts are received on loans for
which the accrual of interest has been discontinued, we decide whether payments
received should be recorded as a reduction of the principal balance or as
interest income depending on our analysis of the collectibility of principal.
The loan is returned to accrual status when we believe the borrower has
demonstrated the ability to make periodic interest and principal payments on a
timely basis.

                                       57
Real estate acquired as a result of foreclosure is classified as real
estate acquired in settlement of loans until such time as it is sold and is
recorded at the lower of the estimated fair value of the underlying real estate
or the carrying amount of the loan. Subsequent costs directly related to
development and improvement of property are capitalized, whereas costs related
to holding property are expensed. Any required write-down of the loan to its
fair value less estimated selling costs upon foreclosure is charged against the
allowance for loan losses. See Note 1 of Notes to Consolidated Financial
Statements.

       The following table sets forth information with respect to our
nonperforming assets at the dates indicated. At the dates shown, we had no
restructured loans within the meaning of Statement of Financial Accounting
Standards No. 114, as amended.
AT SEPTEMBER 30,
                                                     ----------------------------------------------------------------
                                                       1998         1997         1996         1995            1994
                                                     ---------    ---------    ---------    ---------      ----------
                                                                        (DOLLARS IN THOUSANDS)
Loans accounted for on a nonaccrual basis (1)......  $    263     $    259     $    288     $  3,661       $     99
                                                     ========     ========     ========     ========       ========
 
Accruing loans which are contractually past due
  90 days or more..................................  $     --     $     --     $     --     $     --       $     --
                                                     ========     ========     ========     ========       ========
 
      Total nonperforming loans....................  $    263     $    259     $    288     $  3,661       $     99
                                                     ========     ========     ========     ========       ========
 
Total loans........................................  $200,010     $199,876     $176,345     $173,316       $155,962
                                                     ========     ========     ========     ========       ========
Percentage of total loans..........................      0.13%        0.13%        0.16%        2.11%          0.06%
                                                     ========     ========     ========     ========       ========
Other non-performing assets (2)....................  $     --     $     --     $      1     $      1       $  3,202
                                                     ========     ========     ========     ========       ========
Loans modified in troubled debt restructuring......  $     --     $     --     $     --     $     --       $     --
                                                     ========     ========     ========     ========       ========
--------------------
(1)    Payments received on a non-accrual loan are either applied to the
       outstanding principal balance or recorded as interest income, depending
       on management's assessment of the collectibility of the loan.

(2)    Other non-performing assets consist of  property acquired through
       foreclosure or repossession.

       During the years ended September 30, 1998, 1997 and 1996, gross interest
income of $10,000, $27,000 and $26,000, respectively, would have been recorded
on loans accounted for on a nonaccrual basis if the loans had been current
throughout the year. Interest on such loans included in income during the years
ended September 30, 1998, 1997 and 1996 amounted to $15,000, $16,000 and
$12,000, respectively.

       At September 30, 1998 there were no loans which are not currently
classified as non-accrual, 90 days past due or restructured but where known
information about possible credit problems of borrowers causes management to
have serious concerns as to the ability of the borrowers to comply with present
loan repayment terms and may result in disclosure as nonaccrual, 90 days past
due or restructured. See " -- Classified Assets" for information regarding loans
classified as special mention or watch.

      At September 30, 1998, an analysis of our portfolio did not reveal any
impaired loans that needed to be classified under SFAS No. 114.

       At September 30, 1998, we had $263,000 of nonaccrual loans, which
consisted of four single-family mortgage loans.    At September 30, 1998, we
did not have any real estate owned.

       Classified Assets. Regulations require that we classify our assets on a
regular basis. In addition, in connection with examinations of insured
institutions, examiners have authority to identify problem assets and if
appropriate, classify them in their reports of examination. There are three
classifications for problem assets: "substandard," "doubtful" and "loss."
Substandard assets have one or more defined weaknesses and are characterized by
the distinct possibility that  

                                       58
the insured institution will sustain some loss if the deficiencies are not
corrected. Doubtful assets have the weaknesses of substandard assets with the
additional characteristic that the weaknesses make collection or liquidation in
full, on the basis of currently existing facts, conditions and values,
questionable, and there is a high possibility of loss. An asset classified loss
is considered uncollectible and of such little value that continuance as an
asset of the institution is not warranted. Assets classified as substandard or
doubtful require a savings institution to establish general allowances for loan
losses. If an asset or portion thereof is classified loss, a savings institution
must either establish a specific allowance for loss in the amount of the portion
of the asset classified loss, or charge off such amount. The Bank regularly
reviews its assets to determine whether any assets require classification or re-
classification. At September 30, 1998, we had $1.0 million in classified assets
consisting of $990,000 in assets classified as substandard, $20,000 in assets
classified as doubtful and no assets classified as loss.

       In addition to regulatory classifications, we also classify as special
mention or watch assets that are currently performing in accordance with their
contractual terms but may be classified or nonperforming assets in the future.
At September 30, 1998 we have identified approximately $11.5 million in assets
classified as special mention or watch. Included in this amount are three loans
with an aggregate outstanding balance of $3.5 million at September 30, 1998 to a
company affiliated with one of our directors. In addition to the outstanding
balance on the loans, the borrower has the ability to borrow an additional
$256,000 from us under lines of credit. All the loans are secured by a first
lien on all company assets, including accounts receivable, inventory, equipment,
furniture and real property occupied by the borrower. In addition, the director
has personally guaranteed repayment of the loans. At September 30, 1998, such
loans were current with respect to their payment terms and, except for the
waiver of certain debt covenants by the Bank, were performing in accordance with
the related loan agreements. Based on an analysis of the borrower's current
financial statements, management has concerns that the borrower may have
difficulty in complying with the present loan repayment terms on an ongoing
basis.

       Allowance for Loan Losses. Our policy is to establish reserves for
estimated losses on delinquent loans when we determine that losses are expected
to be incurred on such loans. We maintain the allowance for losses on loans at a
level we believe to be adequate to absorb potential losses in the portfolio. Our
determination of the adequacy of the allowance is based on an evaluation of the
portfolio, past loss experience, current economic conditions, volume, growth and
composition of the portfolio, and other relevant factors. The allowance is
increased by provisions for loan losses which are charged against income.

       Although we believe we use the best information available to make
determinations with respect to the allowance for losses and believe such
allowances are adequate, future adjustments may be necessary if economic
conditions differ substantially from the economic conditions in the assumptions
used in making the initial determinations. We anticipate that our allowance for
loan losses will increase in the future as we implement the Board of Directors'
strategy of continuing existing lines of business while gradually expanding
commercial and consumer lending, which loans generally entail greater risks than
single-family residential mortgage loans.

       Banking regulatory agencies, including the FDIC, have adopted a policy
statement regarding maintenance of an adequate allowance for loan and lease
losses and an effective loan review system. This policy includes an arithmetic
formula for checking the reasonableness of an institution's allowance for loan
loss estimate compared to the average loss experience of the industry as a
whole. Examiners will review an institution's allowance for loan losses and
compare it against the sum of: (i) 50% of the portfolio that is classified
doubtful; (ii) 15% of the portfolio that is classified as substandard; and (iii)
for the portions of the portfolio that have not been classified (including those
loans designated as special mention), estimated credit losses over the upcoming
12 months given the facts and circumstances as of the evaluation date. This
amount is considered neither a "floor" nor a "safe harbor" of the level of
allowance for loan losses an institution should maintain, but examiners will
view a shortfall relative to the amount as an indication that they should review
management's policy on allocating these allowances to determine whether it is
reasonable based on all relevant factors.

                                       59
We have our own allowance for loan loss model which is similar to the
FDIC model. Our model indicated that the allowance for loan losses was adequate
at September 30, 1998.

       The following table sets forth an analysis of our allowance for loan
losses for the periods indicated.
YEAR ENDED SEPTEMBER 30,
                                                -----------------------------------------------------------
                                                   1998        1997         1996         1995        1994
                                                ---------    ---------   ---------    ----------   --------
                                                               (DOLLARS IN THOUSANDS)
Balance at beginning of period.............     $  2,754     $  2,496    $  2,223     $   1,767    $  1,540
                                                --------     --------    --------     ---------    --------
 
Loans charged off..........................            4            7          13             5          17
                                                --------     --------    --------     ---------    --------
 
Recoveries.................................            1            4           5             7           4
                                                --------     --------    --------     ---------    --------
 
Net loans charged off......................            3            3           8            (2)         13
                                                --------     --------    --------     ---------    --------
 
Provision for loan losses..................          477          261         281           454         240
                                                --------     --------    --------     ---------    --------
 
Balance at end of period...................     $  3,228     $  2,754    $  2,496     $   2,223    $  1,767
                                                ========     ========    ========     =========    ========
 
Average loans outstanding.................      $199,203     $186,413    $171,148     $ 165,347    $150,722
                                                ========     ========    ========     =========    ========
 
Ratio of net loans charged off to average
  loans outstanding during the period......       0.0015%      0.0016%     0.0047%      (0.0012)%    0.0086% 
                                                ========     ========    ========     =========    ========
60
The following table allocates the allowance for loan losses by loan
category at the dates indicated. The allocation of the allowance to each
category is not necessarily indicative of future losses and does not restrict
the use of the allowance to absorb losses in any category.
AT SEPTEMBER 30,
                             -------------------------------------------------------------------------------------------------------
                                     1998                 1997                 1996                1995                  1994
                             -------------------  -------------------  -------------------  -------------------  -------------------
                                     PERCENT OF           PERCENT OF           PERCENT OF           PERCENT OF           PERCENT OF 
                                       LOANS IN             LOANS IN             LOANS IN             LOANS IN             LOANS IN 
                                     CATEGORY TO          CATEGORY TO          CATEGORY TO          CATEGORY TO          CATEGORY TO
                             AMOUNT  TOTAL LOANS  AMOUNT  TOTAL LOANS  AMOUNT  TOTAL LOANS  AMOUNT  TOTAL LOANS  AMOUNT  TOTAL LOANS
                             ------  -----------  ------  -----------  ------  -----------  ------  -----------  ------  -----------
                                                                     (DOLLARS IN THOUSANDS)
Real estate mortgage:                                                      
 Single-family residential.. $  400     48.84%    $  376     53.76%    $  387     55.70%    $  326     55.78%    $  277     57.51%
 Commercial.................    898     18.76        854     17.02        882     19.62        788     20.23        583     18.89
 Home equity................    319      8.17        318      8.99        303      8.82        272      9.28        233      9.67
 Construction...............    458      8.99        380      6.24        232      4.36        235      4.01        173      3.58
Commercial..................    815     12.19        540     11.34        450      9.44        374      8.52        294      8.13
Consumer....................    338      3.05        286      2.65        242      2.06        228      2.18        207      2.22
                             ------    ------     ------    ------     ------    ------     ------    ------     ------    ------
   Total allowance for
     loan losses............ $3,228    100.00%    $2,754    100.00%    $2,496    100.00%    $2,223    100.00%    $1,767    100.00%
                             ======    ======     ======    ======     ======    ======     ======    ======     ======    ======
61
INVESTMENT ACTIVITIES

       General. Interest income from investment securities generally provides
our second largest source of income after interest on loans. The Board of
Directors has authorized investment in U.S. Government and agency securities,
state government obligations, municipal securities, obligations of the FHLB,
mortgage-backed securities issued by FNMA, the GNMA and FHLMC and any other
securities authorized by the Administrator as permissible investments. Our
objective is to use such investments to reduce interest rate risk, enhance
yields on assets and provide liquidity. At September 30, 1998, the amortized
cost of our investment securities portfolio amounted to $39.9 million, which
included $34.1 million of U.S. Government and agency securities, $1.7 million of
mortgage-backed securities and $108,000 of collateralized mortgage obligations
("CMO's"). In addition, at September 30, 1998, we had a $4.0 million investment
in two mutual funds that invest in U.S. Government and agency securities and
mortgage-backed securities. At such date, we had an unrealized gain of $93,000,
net of deferred taxes, with respect to our investment securities classified as
available for sale.

       The Board of Directors has established an investment policy that sets
forth investment and aggregate investment limitations and credit quality
parameters of each class of investment security. Securities purchases are
subject to the oversight of our Executive Committee. The President has authority
to make specific investment decisions within the parameters determined by the
Board of Directors.

       Pursuant to SFAS No. 115, we had securities with an aggregate cost of
$9.7 million and an approximate fair value of $9.9 million at September 30, 1998
as available for sale. The impact on our financial statements was an after-tax
increase in net worth of approximately $93,000 as of September 30, 1998. The
unrealized gains at September 30, 1998 in our portfolio of investment securities
and mortgage-backed securities were due to decreases in interest rates
subsequent to the acquisition of such securities. Securities designated as "held
to maturity" are those assets which we have the ability and intent to hold to
maturity. Upon acquisition, securities are classified as to our intent. The held
to maturity investment portfolio is not used for speculative purposes and is
carried at amortized cost. Securities designated as "available for sale" are
those assets which we may not hold to maturity and thus are carried at fair
value with unrealized gains or losses, net of tax effect, recognized in net
worth.

       Management periodically evaluates investment securities for other than
temporary declines in value and records any losses through an adjustment to
earnings. During the year ended September 30, 1998, we recognized a loss of
approximately $269,000 on the write down of marketable equity securities for an
other than temporary decline in value.

       At September 30, 1998, we had $4.0 million of U.S. Government and agency
securities classified as available for sale, which carry unrealized after-tax
gains of $26,000, and $30.1 million of U.S. Government and agency securities
classified as held to maturity. We attempt to maintain a high degree of
liquidity in our investment securities portfolio by choosing those that are
readily marketable. As of September 30, 1998, the estimated weighted average
life of our U.S. Government and agency securities was approximately 4 years, and
the average yield on our portfolio of U.S. Government and agency securities was
6.22%. In addition, at September 30, 1998, we had $1.3 million of FHLB of
Atlanta stock.

       Mortgage-Backed and Related Securities. Included in our portfolio of
investment securities are mortgage-backed and mortgage-related securities.
Mortgage-backed securities represent a participation interest in a pool of
single-family or multi-family mortgages, the principal and interest payments on
which are passed from the mortgage originators through intermediaries that pool
and repackage the participation interest in the form of securities to investors.
Such intermediaries may include quasi-governmental agencies such as FHLMC, FNMA
and GNMA which guarantee the payment of principal and interest to investors.
Mortgage-backed securities generally increase the quality of our assets by
virtue of the guarantees that back them, are more liquid than individual
mortgage loans and may be used to collateralize borrowings or other obligations.
 

                                       62
The FHLMC is a public corporation chartered by the U.S. Government and
owned by the 12 FHLBs and federally insured savings institutions. The FHLMC
issues participation certificates backed principally by conventional mortgage
loans. The FHLMC guarantees the timely payment of interest and the ultimate
return of principal on participation certificates. The FNMA is a private
corporation chartered by the U.S. Congress with a mandate to establish a
secondary market for mortgage loans. The FNMA guarantees the timely payment of
principal and interest on FNMA securities. FHLMC and FNMA securities are not
backed by the full faith and credit of the United States, but because the FHLMC
and the FNMA are U.S. Government-sponsored enterprises, these securities are
considered to be among the highest quality investments with minimal credit
risks.

       The GNMA is a government agency within the Department of Housing and
Urban Development which is intended to help finance government-assisted housing
programs. GNMA securities are backed by FHA-insured and VA-guaranteed loans, and
the timely payment of principal and interest on GNMA securities is guaranteed by
the GNMA and backed by the full faith and credit of the U.S. Government.

       Because the FHLMC, the FNMA and the GNMA were established to provide
support for low- and middle-income housing, there are limits to the maximum size
of loans that qualify for these programs. The limit for FNMA and FHLMC currently
is $227,150.

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

       Mortgage-backed securities generally yield less than the loans which
underlie such securities because of their payment guarantees or credit
enhancements which offer nominal credit risk. In addition, mortgage-backed
securities are more liquid than individual mortgage loans and may be used to
collateralize borrowings in the event that we determined to utilize borrowings
as a source of funds. Mortgage-backed securities issued or guaranteed by the
FNMA or the FHLMC (except interest-only securities or the residual interests in
CMOs, of which we own none) are weighted at no more than 20% for risk-based
capital purposes, compared to a weight of 50% to 100% for residential loans. See
"Regulation --Regulation of the Bank -- Capital Requirements."

       Our mortgage-backed and related securities portfolio consists primarily
of seasoned fixed-rate and adjustable-rate, mortgage-backed and related
securities. We make such investments in order to manage cash flow, diversify
assets, obtain yield and to satisfy certain requirements for favorable tax
treatment.

       At September 30, 1998, the weighted average contractual maturity of our
mortgage-backed securities, all of which carried fixed rates, was approximately
5 years. The actual maturity of a mortgage-backed security varies, depending on
when the mortgagors prepay or repay the underlying mortgages. Prepayments of the
underlying mortgages may shorten the life of the investment, thereby adversely
affecting its yield to maturity and the related market value of the mortgage-
backed security. The yield is based upon the interest income and the
amortization of the premium or accretion of the discount related to the 
mortgage-backed security. Premiums and discounts on mortgage-backed securities
are amortized or accreted over the estimated term of the securities using a
level yield method. The prepayment assumptions used to determine the
amortization period for premiums and discounts can significantly affect the
yield of the mortgage-backed security, and these assumptions are reviewed
periodically to reflect the actual prepayment. The actual prepayments of the
underlying mortgages depend on many factors, including the type of mortgage, the
coupon rate, the age of the mortgages, the geographical location of the
underlying real estate collateralizing the mortgages and general levels of
market interest rates. The difference between the interest rates on the
underlying mortgages and the prevailing mortgage interest rates is an important
determinant in the rate of prepayments. During periods of falling mortgage
interest rates, prepayments generally increase, and, conversely, during periods
of rising mortgage interest

                                       63
rates, prepayments generally decrease. If the coupon rate of the underlying
mortgage significantly exceeds the prevailing market interest rates offered for
mortgage loans, refinancing generally increases and accelerates the prepayment
of the underlying mortgages.

       At September 30, 1998, mortgage-backed securities with an amortized cost
of $1.7 million and a carrying value of $1.8 million were held as available for
sale. No mortgage-backed securities were classified as held to maturity.
Mortgage-backed securities classified as available for sale are carried at fair
value. Unrealized gains and losses on available for sale mortgage-backed
securities are recognized as direct increases or decreases in net worth, net of
applicable income taxes. See Notes 1 and 2 of the Notes to Consolidated
Financial Statements. At September 30, 1998, our mortgage-backed securities had
a weighted average yield of 8.20%.

       Mortgage-related securities, which include CMOs, are typically issued by
a special purpose entity, which may be organized in a variety of legal forms,
such as a trust, a corporation or a partnership. The entity aggregates pools of
pass-through securities, which are used to collateralize the mortgage-related
securities. Once combined, the cash flows can be divided into "tranches" or
"classes" of individual securities, thereby creating more predictable average
lives for each security than the underlying pass-through pools. Accordingly,
under this security structure, all principal paydowns from the various mortgage
pools are allocated to a mortgage-related securities' class or classes
structured to have priority until it has been paid off. These securities
generally have fixed interest rates, and, as a result, changes in interest rates
generally would affect the market value and possibly the prepayment rates of
such securities.

       Some mortgage-related securities instruments are like traditional debt
instruments due to their stated principal amounts and traditionally defined
interest rate terms. Purchasers of certain other mortgage-related securities
instruments are entitled to the excess, if any, of the issuer's cash flows.
These mortgage-related securities instruments may include instruments designated
as residual interest and are riskier in that they could result in the loss of a
portion of the original investment. Cash flows from residual interests are very
sensitive to prepayments and, thus, contain a high degree of interest rate risk.
We do not purchase residual interests in mortgage-related securities.

       At September 30, 1998, we had within our investment securities portfolio
CMOs with an amortized cost of $108,000, representing less than .1% of total
assets. Our CMOs had a weighted average yield of 6.57% at September 30, 1998.

       The following table sets forth the carrying value of our investment
securities portfolio at the dates indicated.
At September 30,       
                                                 ----------------------------  
                                                 1998        1997        1996  
                                                 ----        ----        ----  
                                                        (In thousands)
Securities available for sale:                                                 
  U.S. government and agency securities....    $  4,043    $  4,012    $  7,938
  FHLMC....................................         662       1,564       2,131
  GNMA.....................................       1,147       1,754       1,981
  FNMA.....................................          --          29          58
  Marketable equity securities (1).........       4,006       3,961       3,916
                                               --------    --------    --------
      Total................................    $  9,858    $ 11,320    $ 16,024
                                               ========    ========    ========
                                                                               
Securities held to maturity:                                                   
  U.S. government and agency securities....    $ 30,087    $ 23,338    $ 21,317
  CMOs.....................................         108         144         368
                                               --------    --------    --------
      Total................................    $ 30,195    $ 23,482    $ 21,685
                                               ========    ========    ========
_________
(1)  Consists of an investment in two mutual funds.

                                       64
The following table sets forth the scheduled maturities, carrying values,
amortized cost and average yields for our investment securities and mortgage-
backed securities portfolio at September 30, 1998.
ONE YEAR OR LESS       ONE TO FIVE YEARS      FIVE TO TEN YEARS    MORE THAN TEN YEARS
                                         ------------------     ------------------     ------------------    -------------------
                                         CARRYING   AVERAGE     CARRYING   AVERAGE     CARRYING   AVERAGE     CARRYING   AVERAGE
                                           VALUE     YIELD        VALUE     YIELD        VALUE     YIELD        VALUE     YIELD
                                         --------   -------     --------   -------     --------   -------     --------   -------
                                                                         (DOLLARS IN THOUSANDS)
Securities available for sale:
  U.S. government and agency
    securities........................   $     --      -- %     $  3,043     6.25%     $  1,000     6.23%     $     --      -- %
  Mortgage-backed securities..........         --      --             --       --           251     7.81         1,558     8.26
  Marketable equity securities (1)....         --      --          2,013     4.79         1,993     6.49            --      --
                                         --------               --------               --------               --------
       Total..........................   $     --      --       $  5,056     5.67      $  3,244     6.51      $  1,558     8.26
                                         ========               ========               ========               ========

Securities held to maturity:
  U.S. government and agency
    securities........................   $  3,992     6.13%     $ 15,471     6.18%     $  9,624     6.22%     $  1,000     7.00%
  CMOs................................         --      --             --       --            --       --           108     6.57
                                         --------               --------               --------               --------
       Total..........................   $  3,992     6.13      $ 15,471     6.18      $  9,624     6.22      $  1,108     6.96
                                         ========               ========               ========               ========
TOTAL INVESTMENT PORTFOLIO
                                         -----------------------------
                                         CARRYING    MARKET    AVERAGE
                                           VALUE      VALUE     YIELD
                                         --------   --------   -------
Securities available for sale:
  U.S. government and agency
    securities........................   $  4,043   $  4,043     6.25%
  Mortgage-backed securities..........      1,809      1,809     8.20
  Marketable equity securities (1)....      4,006      4,006     5.64
                                         --------   --------
       Total..........................   $  9,858   $  9,858     6.34
                                         ========   ========

Securities held to maturity:
  U.S. government and agency
    securities........................   $ 30,087   $ 30,307     6.22%
  CMOs................................        108        108     6.57
                                         --------   --------
       Total..........................   $ 30,195   $ 30,415     6.22
                                         ========   ========
_________
(1)  Consists of an investment in two mutual funds.

                                       65
DEPOSIT ACTIVITY AND OTHER SOURCES OF FUNDS

       General.  Deposits are our primary source of funds for lending,
investment activities and general operational purposes. In addition to deposits,
we derive funds from loan principal and interest repayments, maturities of
investment securities and interest payments thereon. Although loan repayments
are a relatively stable source of funds, deposit inflows and outflows are
significantly influenced by general interest rates and money market conditions.
Borrowings may be used on a short-term basis to compensate for reductions in the
availability of funds, or on a longer term basis for general operational
purposes. We have access to FHLB of Atlanta advances. Following the Bank
Conversion, we will continue to have access to FHLB of Atlanta advances.

       Deposits.  We attract deposits principally from within our market area by
offering a variety of deposit instruments, including checking accounts, money
market accounts, passbook and statement savings accounts, Individual Retirement
Accounts, and certificates of deposit which range in maturity from seven days to
five years. Deposit terms vary according to the minimum balance required, the
length of time the funds must remain on deposit and the interest rate.
Maturities, terms, service fees and withdrawal penalties for our deposit
accounts are established by us on a periodic basis. We review our deposit
pricing on a weekly basis. In determining the characteristics of our deposit
accounts, we consider the rates offered by competing institutions, lending and
liquidity requirements, growth goals and applicable regulations. Management
believes we price our deposits comparably to rates offered by our competitors.
We do not accept brokered deposits.

       We compete for deposits with other institutions in our market area by
offering competitively priced deposit instruments that are tailored to the needs
of our customers. Additionally, we seek to meet customers' needs by providing
convenient customer service to the community, efficient staff and convenient
hours of service. Substantially all of our depositors are North Carolina
residents. To provide additional convenience, we participate in the HONOR and
CIRRUS Automatic Teller Machine networks at locations throughout the world,
through which customers can gain access to their accounts at any time. To better
serve our customers, we have installed automatic teller machines at five office
locations.

                                     66
Our savings deposits at September 30, 1998 were represented by the
  various types of savings programs described below.
Weighted
  Average
  Interest         Minimum                                                    Minimum      Balance (in       Percentage of
    Rate           Term            Category                                   Amount       Thousands)        Total Deposits
 ---------        --------         --------                                   -------     -------------      --------------
--             None            Non-interest-bearing checking accounts     $    100       $  8,624             3.66%
  2.29%            None            NOW accounts                                    300         25,080            10.64
  2.84             None            Savings Accounts                                100         28,091            11.92
  3.93             None            Money Market Accounts                         1,000         13,238             5.62
 
 
                                   Certificates of Deposit
                                   --------------------------------------
 
  4.26             3 months        Fixed-term, fixed-rate                          500            231             0.10
  4.95             6 months        Fixed-term, fixed-rate                          500          7,098             3.01
  4.94             7 months (1)    Fixed-term, fixed-rate                        5,000         44,862            19.04
  5.23             9 months        Fixed-term, fixed-rate                          500          2,123             0.90
  5.00             10 months       Fixed-term, fixed-rate                        5,000          4,910             2.08
  5.35             12 months       Fixed-term, fixed-rate                          500         41,125            17.45
  5.27             18 months       Floating rate IRA                                50          1,089             0.46
  5.49             18 months       Fixed-term, fixed-rate                          500          2,355             1.00
  4.74             20 months       Fixed-term, fixed-rate                          500             33             0.01
  5.41             24 months       Fixed-term, fixed-rate                          500          9,884             4.19
  5.75             30 months       Fixed-term, fixed-rate                          500         17,610             7.47
  5.45             36 months       Fixed-term, fixed-rate                          500          4,028             1.71
  5.52             48 months       Fixed-term, fixed-rate                          500          4,553             1.93
  5.58             60 months       Fixed-term, fixed-rate                          500         17,856             7.58
  5.14             7 to 365 days   Fixed-term, fixed-rate                      100,000          2,904             1.23
                                                                                             --------           ------
                                                                                             $235,694           100.00%
                                                                                             ========           ======
-------------
  (1)  These certificates of deposit do not carry a penalty for early
       withdrawal. As a result, we believe that should interest rates increase
       materially after September 30, 1998, borrowers may withdraw funds
       invested in these certificates prior to maturity, causing our cost of
       funds to increase.

                                       67
The following table sets forth the distribution of our deposit accounts
  at the dates indicated and the change in dollar amount of deposits in the
  various types of accounts we offer between the dates indicated.
Balance at                            Balance at                            Balance at
                              September 30,     % of      Increase   September 30,     % of      Increase   September 30,     % of
                                   1998       Deposits   (Decrease)       1997       Deposits   (Decrease)       1996       Deposits
                              --------------  ---------  ----------  --------------  ---------  ----------  -------------- ---------
                                                                      (Dollars in thousands)
Noninterest-bearing demand..       $  8,624       3.66%   $  2,078        $  6,546       2.85%   $  3,438      $  3,108     1.48%
Interest-bearing checking...         25,080      10.64         930          24,150      10.53       2,287        21,863    10.43
Money market accounts.......         13,238       5.62       2,120          11,118       4.85       2,006         9,112     4.35
Passbook and savings........         28,091      11.92         391          27,700      12.08        (764)       28,464    13.57
Certificates of deposit.....        160,661      68.16         834         159,827      69.69      12,667       147,160    70.17
                                   --------     ------    --------        --------    -------    --------      --------   ------
                                   $235,694     100.00%     $6,353        $229,341     100.00%    $19,634      $209,707   100.00%  
                                   ========     ======    ========        ========    =======    ========      ========   ======
68
The following table sets forth the average balances and average interest
  rates based on daily balances for various types of deposits at the dates
  indicated for each category of deposits presented.
Year Ended September 30,
                                        ------------------------------------------------------------------
                                               1998                   1997                    1996
                                        ------------------    -------------------     --------------------
                                        Average    Average     Average    Average     Average     Average
                                        Balance      Rate      Balance      Rate      Balance       Rate
                                        --------   -------     -------    -------     -------     --------
                                                               (Dollars in thousands)
Noninterest-bearing demand........    $  6,417      --  %    $  4,972       -- %    $  3,056       -- %
  Interest-bearing checking.........      24,987      2.21       23,975      2.23       21,187      2.19
  Money market accounts.............      12,277      3.82       10,638      3.42        9,883      3.10
  Passbook and savings..............      28,017      2.85       28,650      2.85       29,051      2.85
  Certificates of deposit...........     159,053      5.36      152,231      5.27      142,655      5.50
                                        --------               --------               --------      
      Total.........................    $230,751      4.48     $220,466      4.42     $205,832      4.59
                                        ========               ========               ========
The following table sets forth our time deposits classified by rates at
  the dates indicated.
At September 30,
                                                     ----------------------------------------
                                                       1998            1997             1996
                                                     -------          ------           ------
                                                                  (In thousands)
2 - 3.99%....................................      $     --       $    220          $    294
  4 - 5.99%....................................       149,064        147,667           129,549
  6 - 7.99%....................................        11,496         11,843            17,228
  8 - 9.99%....................................           101             97                89
                                                     --------       --------          --------
                                                     $160,661       $159,827          $147,160
                                                     ========       ========          ========
The following table sets forth the amount and maturities of our time
  deposits at September 30, 1998.
Amount Due
                                 -----------------------------------------------
                                 Less Than                                After
Rate                             One Year     1-2 Years    2-3 Years     3 Years       Total
----                             ---------    ---------    ---------     -------      ------
                                                     (In thousands)
4.00 - 5.99%................    $108,512      $  22,193    $  10,390    $  7,969    $  149,064
6.00 - 7.99%................       8,016          3,020          253         207        11,496
8.00 - 9.99%................          --             --           --         101           101
                                --------      ---------    ---------    --------     ---------
                                $116,528      $  25,213    $  10,643    $  8,277    $  160,661
                                ========      =========    =========    ========     =========
69
The following table indicates the amount of our certificates of deposit
  of $100,000 or more by time remaining until maturity as of September 30, 1998.
  At that date, such deposits represented 12.6% of total deposits and had a
  weighted average rate of 5.41%.
 
                                                    Certificates
                Maturity Period                     of Deposit
                ---------------                     -------------
                                                   (In thousands)
 
                Three months or less.............      $ 9,937
                Over three through six months....        6,050
                Over six through 12 months.......        9,276
                Over 12 months...................        4,437
                                                       -------
                Total............................      $29,700
                                                       =======
 
       We estimate that more than $29 million of certificates of deposit in
  amounts of $100,000 or more maturing within one year of September 30, 1998
  were held by retail and commercial customers of the Bank, while the remainder
  of such deposits were from schools, municipalities and other public entities
  and were obtained through competitive rate bidding.  We believe certificates
  of deposits held by our retail and commercial customers are more likely to be
  renewed upon maturity than certificates of deposit obtained through
  competitive bidding.

       The following table sets forth our savings activities for the periods
  indicated.
Year Ended September 30,
                                                       -------------------------------------
                                                        1998           1997           1996
                                                       ------         ------         ------
                                                                    (In thousands)
Net increase (decrease) before interest credited..    $(3,026)      $10,693       $   163
  Interest credited.................................      9,379         8,941         8,775
                                                        -------       -------       -------
      Net increase in deposits......................    $ 6,353       $19,634       $ 8,938
                                                        =======       =======       =======
In the unlikely event the Bank is liquidated after the Stock Conversion,
  depositors will be entitled to full payment of their deposit accounts prior to
  any payment being made to the sole stockholder of the Converted Bank, which is
  the Company.

       Borrowings.  Savings deposits historically have been the primary source
  of funds for our lending, investments and general operating activities.  We
  are authorized, however, to use advances from the FHLB of Atlanta to
  supplement our supply of lendable funds and to meet deposit withdrawal
  requirements.  The FHLB of Atlanta functions as a central reserve bank
  providing credit for savings institutions and certain other member financial
  institutions.  As a member of the FHLB System, we are required to own stock in
  the FHLB of Atlanta and are authorized to apply for advances.  Advances are
  obtained pursuant to several different programs, each of which has its own
  interest rate and range of maturities.  We have a Blanket Agreement for
  advances with the FHLB under which we may borrow up to 25% of assets subject
  to normal collateral and underwriting requirements.  Advances from the FHLB of
  Atlanta are secured by our stock in the FHLB of Atlanta and other eligible
  assets.  We will remain as a member of the FHLB system following the Bank
  Conversion.

       In February 1998, we obtained $20.0 million in fixed-rate FHLB of Atlanta
  advances.  These advances were structured with maturities estimated to
  coincide with the expected repricing of $20.0 million of loans.  Through this
  strategy, we were able to establish a positive interest rate spread on the
  $20.0 million of assets and FHLB of Atlanta 

                                       70
advances.  See "Management's Discussion and Analysis of Financial Condition
  and Results of Operations --Asset/Liability Management."

       The following table sets forth certain information regarding our short-
  term borrowings at the dates and for the periods indicated:

  
                                                         At or For the
                                                     Year Ended September 30,
                                                  -----------------------------
                                                      1998     1997       1996
                                                      -----    ----       -----
                                                   (Dollars in thousands)

  Amounts outstanding at end of period:
    FHLB advances.........................          $20,000   $1,000     $1,000
  Weighted average rate paid on:   
    FHLB advances.........................             5.39%    5.57%      5.48%
   

                                                          For the Year
                                                        Ended September 30,
                                                  -----------------------------
                                                     1998      1997       1996
                                                     ----      ----       ----
                                                           (In thousands)
  Maximum amount of borrowings outstanding
  at any month end:
    FHLB advances ......................            $21,000   $1,000     $2,000
 
 
                                                         For the Year
                                                        Ended September 30,
                                                  -----------------------------
                                                     1998     1997       1996
                                                    -----     ----       ----
                                                      (Dollars in thousands)
  Average amounts outstanding:
    FHLB advances..........................         $13,559   $1,000     $ 156
  Approximate weighted average rate paid on: (1)
    FHLB advances..........................            5.46%    5.60%     1.92%
  
  -------------------------
  (1)  Based on month-end balances.

  SUBSIDIARY ACTIVITIES

       In prior years, we had one subsidiary, First Capital Services, Inc., a
  North Carolina corporation ("First Capital"), that engaged in sales of
  annuities, mutual funds and insurance products on an agency basis.  In
  September 1997, that corporation transferred its assets and liabilities to a
  newly formed North Carolina limited liability company, First Capital Services
  Company, LLC (the "LLC"), and the corporation was dissolved.  The Bank is the
  sole member of the LLC, and since the transfer of assets and liabilities the
  activities previously conducted by First Capital have been conducted by the
  LLC.  We earned $262,000 and $232,000 on a pre-tax basis from the activities
  of the LLC and First Capital during the years ended September 30, 1998 and
  1997, respectively.

  COMPETITION

       We face strong competition in originating real estate, commercial
  business and consumer loans and in attracting deposits.  We compete for real
  estate and other loans principally on the basis of interest rates, the types
  of loans we originate, the deposit products we offer and the quality of
  services we provide to our customers.  We also compete by offering products
  which are tailored to the local community.  Our competition in originating
  real estate loans comes primarily from other savings institutions, commercial
  banks, mortgage bankers and mortgage brokers.  Commercial 

                                       71
banks, credit unions and finance companies provide vigorous competition in
  consumer lending. Competition may increase as a result of the continuing
  reduction of restrictions on the interstate operations of financial
  institutions.

       We attract our deposits through our branch offices primarily from the
  local communities.  Consequently, competition for deposits is principally from
  other savings institutions, commercial banks, credit unions and brokers in our
  primary market area.  We compete for deposits and loans by offering what we
  believe to be a variety of deposit accounts at competitive rates, convenient
  business hours, a commitment to outstanding customer service and a well-
  trained staff. We believe we have developed strong relationships with local
  realtors and the community in general.

       We consider our primary market area for gathering deposits and
  originating loans to be Alamance County in north central North Carolina, which
  is the county in which our offices are located.  Based on data provided by a
  private marketing firm, we estimate that at June 30, 1997, we had 15.2% of
  deposits held by all banks and savings institutions in our market area.

  OFFICES AND OTHER MATERIAL PROPERTIES

       The following table sets forth the location and certain additional
  information regarding our offices at September 30, 1998.
Book Value at                    Deposits at
                          Year   Owned or     September 30,     Approximate   September 30,
                         Opened  Leased         1998 (1)      Square Footage    1998
                         ------  ------    ----------------   --------------  --------------
                                        (Dollars in thousands)
MAIN OFFICE:
445 S. Main Street       1988    Owned       $3,839              33,700         $101,149
Burlington, NC  27215
 
BRANCH OFFICES:
2294 N. Church Street    1984    Leased(2)      277               2,600           24,520
Burlington, NC  27215
 
503 Huffman Mill Road    1982    Owned          348               2,600           42,614
Burlington, NC  27215
 
102 S. 5th Street        1973    Owned           55               2,000           22,573
Mebane, NC  27302
 
221 N. Main Street       1974    Owned          110               2,700           32,226
Graham, NC  27253

3466 S. Church Street    1996    Owned        1,451               4,000           12,612
Burlington, NC  27215
__________
(1) Land and building only.
(2) Land is leased. Lease expires on July 5, 2009, with options to extend for
    three five-year periods.

       The book value of our investment in premises and equipment was $7.5
  million at September 30, 1998.  See Note 6 of Notes to Consolidated Financial
  Statements.

  EMPLOYEES

       As of September 30, 1998, we had 68 full-time and 11 part-time employees,
  none of whom were represented by a collective bargaining agreement.  We
  believe that our relationship with our employees is good.

                                       72
LEGAL PROCEEDINGS

       From time to time, we are a party to various legal proceedings incident
  to its business.  There currently are no legal proceedings to which we are a
  party, or to which any of our property was subject, which were expected to
  result in a material loss.  There are no pending regulatory proceedings to
  which we are a party or to which any of our properties is subject which are
  expected to result in a material loss.

                                    REGULATION

  DEPOSITORY INSTITUTION REGULATION

       General.  We are a North Carolina-chartered savings bank and a member of
  the FHLB of Atlanta and our deposits are insured by the FDIC through the SAIF.
  As a North Carolina savings bank, we are subject to regulation and supervision
  by the Administrator and the FDIC and to North Carolina and FDIC regulations
  governing such matters as capital standards, mergers, establishment of branch
  offices, subsidiary investments and activities and general investment
  authority.  The Administrator and the FDIC periodically examine us for
  compliance with various regulatory requirements and for safe and sound
  operations.  The FDIC also has the authority to conduct special examinations
  of us because our deposits are insured by the SAIF.  We must file reports with
  the Administrator describing our activities and financial condition and must
  obtain the approval from the Administrator and the FDIC prior to entering into
  certain transactions, such as mergers with, or acquisitions of, other
  depository institutions.

       Upon consummation of the Bank Conversion, the Converted Bank will be a
  North Carolina commercial bank and its deposit accounts will continue to be
  insured by the SAIF.  The Converted Bank will be subject to supervision,
  examination and regulation by the Commissioner (rather than the Administrator)
  and the FDIC and to North Carolina and federal statutory and regulatory
  provisions governing such matters as capital standards, mergers, subsidiary
  investments and establishment of branch offices, and it will remain subject to
  the FDIC's authority to conduct special examinations.  The Converted Bank will
  be required to file reports with the Commissioner and the FDIC concerning its
  activities and financial condition and will be required to obtain regulatory
  approvals prior to entering into certain transactions, including mergers with,
  or acquisitions of, other depository institutions.

       As a federally insured depository institution, we are and the Converted
  Bank will be, subject to various regulations promulgated by the Federal
  Reserve Board, including Regulation B (Equal Credit Opportunity), Regulation D
  (Reserve Requirements), Regulations E (Electronic Fund Transfers), Regulation
  Z (Truth in Lending), Regulation CC (Availability of Funds and Collection of
  Checks) and Regulation DD (Truth in Savings).

       The system of regulation and supervision applicable to us and the
  Converted Bank establishes a comprehensive framework for our operations and
  those of the Converted Bank and is intended primarily for the protection of
  the FDIC and the depositors of the Bank and the Converted Bank.  Changes in
  the regulatory framework could have a material effect on us, the Converted
  Bank and our respective operations that in turn, could have a material effect
  on the Company.

       Proposed Legislative and Regulatory Changes.  On May 13, 1998, the U.S.
  House of Representatives passed H.R. 10 (the "Act"), the Financial Services
  Competition Act of 1998, "which calls for a sweeping modernization of the
  banking system that would permit affiliations between commercial banks,
  securities firms, insurance companies and, subject to certain limitations,
  other commercial enterprises.  The stated purposes of the Act are to enhance
  consumer choice in the financial services marketplace, level the playing field
  among providers of financial services and increase competition.  H.R. 10
  removes the restrictions contained in the Glass-Steagall Act of 1933 and the
  Bank Holding Company Act of 1956, thereby allowing qualified financial holding
  companies to control banks, securities firms, insurance companies, and other
  financial firms.  Conversely, securities firms, insurance companies and
  financial firms would be allowed to own or affiliate with a commercial bank.
  Under the new framework, the Federal Reserve would 

                                       73
serve as an umbrella regulator to oversee the new financial holding company
  structure. Securities affiliates would be required to comply with all
  applicable federal securities laws, including registration and other
  requirements applicable to broker-dealers. The Act also provides the insurance
  affiliates be subject to applicable state insurance regulations and
  supervision. The Act preserves the thrift charter and all existing thrift
  powers, but restricts the activities of new unitary thrift holding companies.

       At the adjournment of Congress in October 1998, the Senate had not voted
  on the legislation and the Act had been returned to the Senate Banking
  Committee for further review  A bill similar to the Act was introduced for
  consideration by Congress when it reconvenes in 1999.  At this time, it is
  unknown whether the Act will be enacted, or if enacted, what form the final
  version of such legislation might take.

       Capital Requirements.  The Federal Reserve Board and the FDIC have
  established guidelines with respect to the maintenance of appropriate levels
  of capital by bank holding companies with consolidated assets of $150 million
  or more and state non-member banks, respectively.  The regulations impose two
  sets of capital adequacy requirements:  minimum leverage rules, which require
  bank holding companies and state non-member banks to maintain a specified
  minimum ratio of capital to total assets, and risk-based capital rules, which
  require the maintenance of specified minimum ratios of capital to "risk-
  weighted" assets.  The regulations of the FDIC and the Federal Reserve Board
  require bank holding companies and state non-member banks, respectively, to
  maintain a minimum leverage ratio of "Tier 1 capital" to total assets of 3%.
  Tier 1 capital is the sum of common stockholders' equity, certain perpetual
  preferred stock (which must be noncumulative with respect to banks), including
  any related surplus, and minority interests in consolidated subsidiaries;
  minus all intangible assets (other than certain purchased mortgage servicing
  rights and purchased credit card receivables), identified losses and
  investments in certain subsidiaries.  As a SAIF-insured, state-chartered bank,
  the Bank must also deduct from Tier 1 capital an amount equal to its
  investments in, and extensions of credit to, subsidiaries engaged in
  activities that are not permissible for national banks, other than debt and
  equity investments in subsidiaries engaged in activities undertaken as agent
  for customers or in mortgage banking activities or in subsidiary depository
  institutions or their holding companies.  Although setting a minimum 3%
  leverage ratio, the capital regulations state that only the strongest bank
  holding companies and banks, with composite examination ratings of 1 under the
  rating system used by the federal bank regulators, would be permitted to
  operate at or near such minimum level of capital.  All other bank holding
  companies and banks are expected to maintain a leverage ratio of at least 1%
  to 2% above the minimum ratio, depending on the assessment of an individual
  organization's capital adequacy by its primary regulator.  Any bank or bank
  holding companies experiencing or anticipating significant growth would be
  expected to maintain capital well above the minimum levels.  In addition, the
  Federal Reserve Board has indicated that whenever appropriate, and in
  particular when a bank holding company is undertaking expansion, seeking to
  engage in new activities or otherwise facing unusual or abnormal risks, it
  will consider, on a case-by-case basis, the level of an organization's ratio
  of tangible Tier 1 capital to total assets in making an overall assessment of
  capital.

       In addition to the leverage ratio, the regulations of the Federal Reserve
  Board and the FDIC require bank holding companies and state-chartered
  nonmember banks to maintain a minimum ratio of qualifying total capital to
  risk-weighted assets of at least 8% of which at least 4% must be Tier 1
  capital.  Qualifying total capital consists of Tier 1 capital plus Tier 2 or
  "supplementary" capital items which include allowances for loan losses in an
  amount of up to 1.25% of risk-weighted assets, cumulative preferred stock and
  preferred stock with a maturity of 20 years or more, certain other capital
  instruments and net unrealized gains on equity securities.  The includible
  amount of Tier 2 capital cannot exceed the institution's Tier 1 capital.
  Qualifying total capital is further reduced by the amount of the bank's
  investments in banking and finance subsidiaries that are not consolidated for
  regulatory capital purposes, reciprocal cross-holdings of capital securities
  issued by other banks and certain other deductions.  The risk-based capital
  regulations assign balance sheet assets and the credit equivalent amounts of
  certain off-balance sheet items to one of four broad risk weight categories.
  The aggregate dollar amount of each category is multiplied by the risk weight
  assigned to that category based principally on the degree of credit risk
  associated with the obligor.  The sum of these weighted values equals the bank
  holding company or the bank's risk-weighted assets.

                                       74
The federal bank regulators, including the Federal Reserve Board and the
  FDIC, have revised their risk-based capital requirements to ensure that such
  requirements provide for explicit consideration of interest rate risk.  Under
  the rule, a bank's interest rate risk exposure would be quantified using
  either the measurement system set forth in the rule or the bank's internal
  model for measuring such exposure, if such model is determined to be adequate
  by the bank's examiner.  If the dollar amount of a bank's interest rate risk
  exposure, as measured under either measurement system, exceeds 1% of the
  bank's total assets, the bank would be required under the rule to hold
  additional capital equal to the dollar amount of the excess.  Management of
  the Bank believes that interest rate risk component does not have a material
  effect on the Bank's capital.  Further, the FDIC has adopted a regulation that
  provides that the FDIC may take into account whether a bank has significant
  risks from concentrations of credit or non-traditional activities in
  determining the adequacy of its capital.  The Bank has not been advised that
  it will be required to maintain any additional capital under this regulation.
  The interest rate risk component does not apply to bank holding companies on a
  consolidated basis.

       In addition to FDIC regulatory capital requirements, the Administrator
  requires that net worth equal at least 5% of total assets.  Intangible assets
  must be deducted from net worth and assets when computing compliance with this
  requirement.

       At September 30, 1998, the Bank complied with each of the capital
  requirements of the FDIC and the Administrator.  For a description of the
  Bank's required and actual capital levels on September 30, 1998, see
  "Historical and Pro Forma Regulatory Capital Compliance."

       Following the Bank Conversion, the Converted Bank will be subject to the
  Commissioner's capital surplus regulation which requires commercial banks to
  maintain a capital surplus of at least 50% of common capital.  Common capital
  is defined as the total of the par value of shares times the number of shares
  outstanding.

       Prompt Corrective Regulatory Action.  Under the Federal Deposit Insurance
  Corporation Improvement Act of 1991 ("FDICIA"), the federal banking regulators
  are required to take prompt corrective action if an insured depository
  institution fails to satisfy certain minimum capital requirements.  All
  institutions, regardless of their capital levels, are restricted from making
  any capital distribution or paying any management fees if the institution
  would thereafter fail to satisfy the minimum levels for any of its capital
  requirements.  An institution that fails to meet the minimum level for any
  relevant capital measure (an "undercapitalized institution") may be: (i)
  subject to increased monitoring by the appropriate federal banking regulator;
  (ii) required to submit an acceptable capital restoration plan within 45 days;
  (iii) subject to asset growth limits; and (iv) required to obtain prior
  regulatory approval for acquisitions, branching and new lines of businesses.
  A "significantly undercapitalized" institution may be subject to statutory
  demands for recapitalization, broader application of restrictions on
  transactions with affiliates, limitations on interest rates paid on deposits,
  asset growth and other activities, possible replacement of directors and
  officers, and restrictions on capital distributions by any bank holding
  company controlling the institution.  Any company controlling the institution
  could also be required to divest the institution or the institution could be
  required to divest subsidiaries.  The senior executive officers of a
  significantly undercapitalized institution may not receive bonuses or
  increases in compensation without prior regulatory approval and the
  institution is prohibited from making payments of principal or interest on its
  subordinated debt.  If an institution's ratio of tangible capital to total
  assets falls below a "critical capital level," the institution will be subject
  to conservatorship or receivership within 90 days unless periodic
  determinations are made that forbearance from such action would better protect
  the deposit insurance fund.

       Federal banking regulators have adopted regulations implementing the
  prompt corrective action provisions of FDICIA.  Under these regulations, the
  federal banking regulators will generally measure a depository institution's
  capital adequacy on the basis of the institution's total risk-based capital
  ratio (the ratio of its total capital to risk-weighted assets), Tier 1 risk-
  based capital ratio (the ratio of its core capital to risk-weighted assets)
  and leverage ratio (the ratio of its core capital to adjusted total assets).
  Under the regulations, an institution that is not subject to an order or
  written directive by its primary federal regulator to meet or maintain a
  specific capital level will be deemed "well capitalized" if it also has: (i) a
  total risk-based capital ratio of 10% or greater; (ii) a Tier 1 risk-based
  capital ratio of 6% or greater; 

                                       75
and (iii) a leverage ratio of 5% or greater. An "adequately capitalized"
  depository institution is an institution that does not meet the definition of
  well capitalized and has: (i) a total risk-based capital ratio of 8% or
  greater; (ii) a Tier 1 risk-based capital ratio of 4% or greater; and (iii) a
  leverage ratio of 4% or greater (or 3% or greater if the depository
  institution has a composite 1 CAMELS rating). An "undercapitalized
  institution" is a depository institution that has (i) a total risk-based
  capital ratio less than 8%; or (ii) a Tier 1 risk-based capital ratio of less
  than 4%; or (iii) a leverage ratio of less than 4% (or less than 3% if the
  institution has a composite 1 CAMELS rating). A "significantly
  undercapitalized" institution is defined as a depository institution that has:
  (i) a total risk-based capital ratio of less than 6%; or (ii) a Tier 1 risk-
  based capital ratio of less than 3%; or (iii) a leverage ratio of less than
  3%. A "critically undercapitalized" institution is defined as a depository
  institution that has a ratio of "tangible equity" to total assets of less than
  2%. Tangible equity is defined as core capital plus cumulative perpetual
  preferred stock (and related surplus) less all intangibles other than
  qualifying supervisory goodwill and certain purchased mortgage servicing
  rights. The appropriate federal banking agency may reclassify a well
  capitalized depository institution as adequately capitalized and may require
  an adequately capitalized or undercapitalized institution to comply with the
  supervisory actions applicable to institutions in the next lower capital
  category (but may not reclassify a significantly undercapitalized institution
  as critically under-capitalized) if it determines, after notice and an
  opportunity for a hearing, that the institution is in an unsafe or unsound
  condition or that the institution has received and not corrected a less-than-
  satisfactory rating for any CAMELS rating category. At September 30, 1998, the
  Bank was classified as "well capitalized" under FDIC regulations, and
  management of the Bank believes that the Converted Bank will, immediately
  after the Conversion, also be classified as "well-capitalized."

       Safety and Soundness Guidelines.  Under FDICIA, as amended by the Riegle
  Community Development and Regulatory Improvement Act of 1994 (the "CDRI Act"),
  each federal banking agency was required to establish safety and soundness
  standards for institutions under its authority.  The interagency guidelines
  require depository institutions to maintain internal controls and information
  systems and internal audit systems that are appropriate for the size, nature
  and scope of the institution's business.  The guidelines also establish
  certain basic standards for loan documentation, credit underwriting, interest
  rate risk exposure, and asset growth.  The guidelines further provide that
  depository institutions should maintain safeguards to prevent the payment of
  compensation, fees and benefits that are excessive or that could lead to
  material financial loss, and should take into account factors such as
  comparable compensation practices at comparable institutions.  If the
  appropriate federal banking agency determines that a depository institution is
  not in compliance with the safety and soundness guidelines, it may require the
  institution to submit an acceptable plan to achieve compliance with the
  guidelines.  A depository institution must submit an acceptable compliance
  plan to its primary federal regulator within 30 days of receipt of a request
  for such a plan.  Failure to submit or implement a compliance plan may subject
  the institution to regulatory sanctions.  Management believes that the Bank
  meets all the standards adopted in the interagency guidelines.

       Community Reinvestment Act.  The Bank, like other financial institutions,
  is subject to the Community Reinvestment Act ("CRA").  The purpose of the CRA
  is to encourage financial institutions to help meet the credit needs of their
  entire communities, including the needs of low- and moderate-income
  neighborhoods.  During the Bank's last compliance examination, the Bank
  received a "satisfactory" rating with respect to CRA compliance.  The Bank's
  rating with respect to CRA compliance would be a factor to be considered by
  the Federal Reserve Board and the FDIC in considering applications submitted
  by the Bank to acquire branches or to acquire or combine with other financial
  institutions and take other actions and, if such rating was less than
  "satisfactory," could result in the denial of such applications.

       The federal banking regulatory agencies have implemented an evaluation
  system that rates institutions based on their actual performance in meeting
  community credit needs.  Under the regulations, a bank will first be evaluated
  and rated under three categories: a lending test, an investment test and a
  service test.  For each of these three tests, the savings bank will be given a
  rating of either "outstanding," "high satisfactory," "low satisfactory,"
  "needs to improve," or "substantial non-compliance."  A set of criteria for
  each rating has been developed and is included in the regulation.  If an
  institution disagrees with a particular rating, the institution has the burden
  of rebutting the presumption by clearly establishing that the quantitative
  measures do not accurately present its actual performance, or that
  demographics, 

                                       76
competitive conditions or economic or legal limitations peculiar to its
  service area should be considered. The ratings received under the three tests
  will be used to determine the overall composite CRA rating. The composite
  ratings will be the same as those that are currently given: "outstanding,"
  "satisfactory," "needs to improve" or "substantial non-compliance."

       Federal Home Loan Bank System.  The FHLB System consists of 12 district
  FHLBs subject to supervision and regulation by the Federal Housing Finance
  Board ("FHFB").  The FHLBs provide a central credit facility primarily for
  member institutions.  As a member of the FHLB of Atlanta, the Bank is required
  to acquire and hold shares of capital stock in the FHLB of Atlanta in an
  amount at least equal to 1% of the aggregate unpaid principal of its home
  mortgage loans, home purchase contracts, and similar obligations at the
  beginning of each year, or 1/20 of its advances (borrowings) from the FHLB of
  Atlanta, whichever is greater.  The Bank was in compliance with this
  requirement with investment in FHLB of Atlanta stock at September 30, 1998 of
  $1.3 million.  The FHLB of Atlanta serves as a reserve or central bank for its
  member institutions within its assigned district.  It is funded primarily from
  proceeds derived from the sale of consolidated obligations of the FHLB System.
  It offers advances to members in accordance with policies and procedures
  established by the FHFB and the Board of Directors of the FHLB of Atlanta.
  Long-term advances may only be made for the purpose of providing funds for
  residential housing finance.  At September 30, 1998, the Bank had $20.0
  million in advances outstanding from the FHLB of Atlanta.  Upon completion of
  the Bank Conversion, the Converted Bank will continue to be a member of the
  FHLB of Atlanta.

       Reserves.  Pursuant to regulations of the Federal Reserve Board, the Bank
  must maintain average daily reserves against their transaction accounts.
  Reserves equal to 3% must be maintained on the first $47.8 million of
  transaction accounts, plus 10% on the remainder.  This percentage is subject
  to adjustment by the Federal Reserve Board.  Because required reserves must be
  maintained in the form of vault cash or in a non-interest bearing account at a
  Federal Reserve Bank, the effect of the reserve requirement is to reduce the
  amount of the institution's interest-earning assets.  As of September 30,
  1998, the Bank met its reserve requirements.

       Upon consummation of the Bank Conversion, the Converted Bank will be
  subject to the reserve requirements of North Carolina commercial banks.  North
  Carolina law requires state non-member banks to maintain, at all times, a
  reserve fund in an amount set by regulation of the Commission.

       Deposit Insurance.  The Bank is required to pay assessments based on a
  percentage of its insured deposits to the FDIC for insurance of its deposits
  by the SAIF.  Under the FDIC's risk-based deposit insurance assessment system,
  the assessment rate for an insured depository institution depends on the
  assessment risk classification assigned to the institution by the FDIC, which
  is determined by the institution's capital level and supervisory evaluations.
  Based on the data reported to regulators for the date closest to the last day
  of the seventh month preceding the semi-annual assessment period, institutions
  are assigned to one of three capital groups -- well capitalized, adequately
  capitalized or undercapitalized -- using the same percentage criteria as in
  the prompt corrective action regulations.  See "-- Prompt Corrective
  Regulatory Action."  Within each capital group, institutions are assigned to
  one of three subgroups on the basis of supervisory evaluations by the
  institution's primary supervisory authority and such other information as the
  FDIC determines to be relevant to the institution's financial condition and
  the risk posed to the deposit insurance fund.  Subgroup A consists of
  financially sound institutions with only a few minor weaknesses.  Subgroup B
  consists of institutions that demonstrate weaknesses which, if not corrected,
  could result in significant deterioration of the institution and increased
  risk of loss to the deposit insurance fund.  Subgroup C consists of
  institutions that pose a substantial probability of loss to the deposit
  insurance fund unless effective corrective action is taken.  In 1996, the FDIC
  imposed a one-time assessment of 65.7 basis points of insured deposits as of
  March 31, 1995, that fully capitalized the SAIF and had the effect of reducing
  future SAIF assessments.  Accordingly, although the special assessment
  resulted in a one-time charge to the Bank of approximately $1.3 million pre-
  tax, the recapitalization of the SAIF had the effect of reducing the Bank's
  and the Converted Bank's future deposit insurance premiums to the SAIF.  Both
  BIF and SAIF members are assessed an amount for the Financing Corporation Bond
  payments.  BIF members are assessed approximately 1.3 basis points while the
  SAIF rate is approximately 6.4 basis points until January 1, 2000.  At that
  time, BIF and SAIF members will begin pro rata sharing of the payment at an
  expected rate of 2.43 basis points.

                                       77
Although the Converted Bank, as a North Carolina commercial bank, would
  qualify for insurance of deposits by the BIF, substantial entrance and exit
  fees apply to conversions from SAIF to BIF insurance.  Accordingly, following
  the Bank Conversion, the Converted Bank will remain a member of the SAIF,
  which will insure the deposits of the Converted Bank to a maximum of $100,000
  for each depositor.  Because the Converted Bank will continue to be a SAIF
  member, its deposit insurance assessments will be determined on the same basis
  as the deposit insurance assessments paid by the Bank.

       Liquidity Requirements.  FDIC policy requires that banks maintain an
  average daily balance of liquid assets (cash, certain time deposits, bankers'
  acceptances and specified United States government, state, or federal agency
  obligations) in an amount which it deems adequate to protect safety and
  soundness of the bank.  The FDIC currently has no specific level which it
  requires.

       The Bank also is subject to the Administrator's requirement that the
  ratio of liquid assets to total assets equal at least 10%.  The computation of
  liquidity under North Carolina regulations allows the inclusion of mortgage-
  backed securities and investments which, in the judgment of the Administrator,
  have a readily ascertainable market value, including investments with
  maturities in excess of five years.  At September 30, 1998, the Bank's
  liquidity ratio exceeded the North Carolina regulations.

       Dividend Restrictions.  Under FDIC regulations, the Bank is prohibited
  from making any capital distributions if after making the distribution, the
  Bank would have: (i) a total risk-based capital ratio of less than 8%; (ii) a
  Tier 1 risk-based capital ratio of less than 4%; or (iii) a leverage ratio of
  less than 4%.

       Earnings of the Bank appropriated to bad debt reserves and deducted for
  Federal income tax purposes are not available for payment of cash dividends or
  other distributions to stockholders without payment of taxes at the then
  current tax rate by the Bank on the amount of earnings removed from the pre-
  1988 reserves for such distributions.  The Bank intends to make full use of
  this favorable tax treatment and does not contemplate use of any earnings in a
  manner which would create federal tax liabilities.

       The Bank may not pay dividends on its capital stock if its regulatory
  capital would thereby be reduced below the amount then required for the
  liquidation account established for the benefit of certain depositors of the
  Bank at the time of the Stock Conversion.

       The Company is subject to limitations on dividends imposed by the Federal
  Reserve Board.  See "-- Regulation of the Company Following the Bank
  Conversion -- Dividends."

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

                                       78
State non-member banks also are subject to the restrictions contained in
  Section 22(h) of the Federal Reserve Act and the Federal Reserve Board's
  Regulation O thereunder on loans to executive officers, directors and
  principal stockholders.  Under Section 22(h), loans to a director, executive
  officer and to a greater than 10% stockholder of a state non-member bank and
  certain affiliated interests of such persons, may not exceed, together with
  all other outstanding loans to such person and affiliated interests, the
  institution's loans-to-one-borrower limit and all loans to such persons may
  not exceed the institution's unimpaired capital and unimpaired surplus.
  Section 22(h) also prohibits loans, above amounts prescribed by the
  appropriate federal banking agency, to directors, executive officers and
  greater than 10% stockholders of a savings institution, and their respective
  affiliates, unless such loan is approved in advance by a majority of the board
  of directors of the institution with any "interested" director not
  participating in the voting.  Regulation O prescribes the loan amount (which
  includes all other outstanding loans to such person) as to which such prior
  board of director approval is required as being the greater of $25,000 or 5%
  of capital and surplus (up to $500,000).  Further, Section 22(h) requires that
  loans to directors, executive officers and principal stockholders be made on
  terms substantially the same as offered in comparable transactions to other
  persons.  Section 22(h) also generally prohibits a depository institution from
  paying the overdrafts of any of its executive officers or directors.

       State non-member banks also are subject to the requirements and
  restrictions of Section 22(g) of the Federal Reserve Act on loans to executive
  officers and the restrictions of 12 U.S.C. (S)1972 on certain tying
  arrangements and extensions of credit by correspondent banks. Section 22(g) of
  the Federal Reserve Act requires loans to executive officers of depository
  institutions not be made on terms more favorable than those afforded to other
  borrowers, requires approval by the board of directors of a depository
  institution for extension of credit to executive officers of the institution,
  and imposes reporting requirements for and additional restrictions on the
  type, amount and terms of credits to such officers.  Section 1972 (i)
  prohibits a depository institution from extending credit to or offering any
  other services, or fixing or varying the consideration for such extension of
  credit or service, on the condition that the customer obtain some additional
  service from the institution or certain of its affiliates or not obtain
  services of a competitor of the institution, subject to certain exceptions,
  and (ii) prohibits extensions of credit to executive officers, directors, and
  greater than 10% stockholders of a depository institution by any other
  institution which has a correspondent banking relationship with the
  institution, unless such extension of credit is on substantially the same
  terms as those prevailing at the time for comparable transactions with other
  persons and does not involve more than the normal risk of repayment or present
  other unfavorable features.

       Restrictions on Certain Activities.  Under FDICIA, state-chartered banks
  with deposits insured by the FDIC are generally prohibited from acquiring or
  retaining any equity investment of a type or in an amount that is not
  permissible for a national bank.  The foregoing limitation, however, does not
  prohibit FDIC-insured state banks from acquiring or retaining an equity
  investment in a subsidiary in which the bank is a majority owner.  State-
  chartered banks are also prohibited from engaging as principal in any type of
  activity that is not permissible for a national bank and subsidiaries of
  state-chartered, FDIC-insured state banks may not engage as principal in any
  type of activity that is not permissible for a subsidiary of a national bank
  unless in either case the FDIC determines that the activity would pose no
  significant risk to the appropriate deposit insurance fund and the bank is,
  and continues to be, in compliance with applicable capital standards.

       The FDIC has adopted regulations to clarify the foregoing restrictions on
  activities of FDIC-insured state-chartered banks and their subsidiaries.
  Under the regulations, the term activity refers to the authorized conduct of
  business by an insured state bank and includes acquiring or retaining any
  investment other than an equity investment.  An activity permissible for a
  national bank includes any activity expressly authorized for national banks by
  statute or recognized as permissible in regulations, official circulars or
  bulletins or in any order or written interpretation issued by the Office of
  the Comptroller of the Currency ("OCC").  In its regulations, the FDIC
  indicates that it will not permit state banks to directly engage in commercial
  ventures or directly or indirectly engage in any insurance underwriting
  activity other than to the extent such activities are permissible for a
  national bank or a national bank subsidiary or except for certain other
  limited forms of insurance underwriting permitted under the regulations.
  Under the regulations, the FDIC permits state banks that meet applicable
  minimum capital requirements to engage as principal in certain activities that
  are not permissible to national banks including guaranteeing obligations of
  others, activities which the Federal 

                                       79
Reserve Board has found by regulation or order to be closely related to
  banking and certain securities activities conducted through subsidiaries.

       Subject to limitation by the Administrator, North Carolina-chartered
  savings banks may make any loan or investment or engage in any activity which
  is permitted to federally chartered institutions.  However, a North Carolina-
  chartered savings bank cannot invest more than 15% of its total assets in
  business, commercial, corporate and agricultural loans.  In addition to such
  lending authority, North Carolina-chartered savings banks are authorized to
  invest funds, in excess of loan demand, in certain statutorily permitted
  investments, including but not limited to (i) obligations of the United
  States, or those guaranteed by it; (ii) obligations of the State of North
  Carolina; (iii) bank demand or time deposits; (iv) stock or obligations of the
  federal deposit insurance fund or a FHLB; (v) savings accounts of any savings
  institution as approved by the board of directors; and (vi) stock or
  obligations of any agency of the State of North Carolina or of the United
  States or of any corporation doing business in North Carolina whose principal
  business is to make education loans.

  REGULATION OF THE COMPANY FOLLOWING THE BANK CONVERSION

       General.  Upon consummation of the Bank Conversion, the Company, as the
  sole shareholder of the Converted Bank, will become a bank holding company and
  will register as such with the Federal Reserve Board.  Bank holding companies
  are subject to comprehensive regulation by the Federal Reserve Board under the
  Bank Holding Company Act of 1956, as amended (the "BHCA"), and the regulations
  of the Federal Reserve Board.  As a bank holding company, the Company will be
  required to file with the Federal Reserve Board annual reports and such
  additional information as the Federal Reserve Board may require, and will be
  subject to regular examinations by the Federal Reserve Board.  The Federal
  Reserve Board also has extensive enforcement authority over bank holding
  companies, including, among other things, the ability to assess civil money
  penalties, to issue cease and desist or removal orders and to require that a
  holding company divest subsidiaries (including its bank subsidiaries).  In
  general, enforcement actions may be initiated for violations of law and
  regulations and unsafe or unsound practices.

       Under the BHCA, a bank holding company must obtain Federal Reserve Board
  approval before: (i) acquiring, directly or indirectly, ownership or control
  of any voting shares of another bank or bank holding company if, after such
  acquisition, it would own or control more than 5% of such shares (unless it
  already owns or controls the majority of such shares); (ii) acquiring all or
  substantially all of the assets of another bank or bank holding company; or
  (iii) merging or consolidating with another bank holding company.
  Satisfactory financial condition, particularly with respect to capital
  adequacy, and a satisfactory CRA rating generally are prerequisites to
  obtaining federal regulatory approval to make acquisitions.

       The BHCA also prohibits a bank holding company, with certain exceptions,
  from acquiring direct or indirect ownership or control of more than 5% of the
  voting shares of any company which is not a bank or bank holding company, or
  from engaging directly or indirectly in activities other than those of
  banking, managing or controlling banks, or providing services for its
  subsidiaries.  The principal exceptions to these prohibitions involve certain
  non bank activities which, by statute or by Federal Reserve Board regulation
  or order, have been identified as activities closely related to the business
  of banking or managing or controlling banks.  The list of activities permitted
  by the Federal Reserve Board includes, among other things, operating a savings
  institution, mortgage company, finance company, credit card company or
  factoring company; performing certain data processing operations; providing
  certain investment and financial advice; underwriting and acting as an
  insurance agent for certain types of credit-related insurance; leasing
  property on a full-payout, non-operating basis; selling money orders,
  travelers' checks and United States Savings Bonds; real estate and personal
  property appraising; providing tax planning and preparation services; and,
  subject to certain limitations, providing securities brokerage services for
  customers.  The Company has no present plans to engage in any of these
  activities.

       Under the BHCA, any company must obtain approval of the Federal Reserve
  Board prior to acquiring control of the Company or the Converted Bank.  For
  purposes of the BHCA, "control" is defined as ownership of more than

                                       80
25% of any class of voting securities of the Company or the Bank, the ability
  to control the election of a majority of the directors, or the exercise of a
  controlling influence over management or policies of the Company or the Bank.
  In addition, the Change in Bank Control Act and the related regulations of the
  Federal Reserve Board require any person or persons acting in concert (except
  for companies required to make application under the BHCA), to file a written
  notice with the Federal Reserve Board before such person or persons may
  acquire control of the Company or the Converted Bank. The Change in Bank
  Control Act defines "control" as the power, directly or indirectly, to vote
  25% or more of any voting securities or to direct the management or policies
  of a bank holding company or an insured bank.

       The Federal Reserve Board has adopted guidelines regarding the capital
  adequacy of bank holding companies, which require bank holding companies to
  maintain specified minimum ratios of capital to total assets and capital to
  risk-weighted assets.  See " -- Depository Institution Regulation -- Capital
  Requirements."

       Interstate Banking.  The Riegle-Neal Interstate Banking and Branching
  Efficiency Act of 1994 (the "Reigle-Neal Act") was enacted to ease
  restrictions on interstate banking.  Effective September 29, 1995, the Act
  allows the Federal Reserve Board to approve an application of an adequately
  capitalized and adequately managed bank holding company to acquire control of,
  or acquire all or substantially all of the assets of, a bank located in a
  state other than such holding company's home state, without regard to whether
  the transaction is prohibited by the laws of any state.  The Federal Reserve
  Board may not approve the acquisition of a bank that has not been in existence
  for a minimum of five years (regardless of a longer minimum period specified
  by the statutory law of the host state).  The Act also prohibits the Federal
  Reserve Board from approving an application if the applicant (and its
  depository institution affiliates) controls or would control more than 10% of
  the insured deposits in the United States or 30% or more of the deposits in
  the target bank's home state or in any state in which the target bank
  maintains a branch.  The Act does not affect the authority of states to limit
  the percentage of total insured deposits in the state which may be held or
  controlled by a bank or bank holding company to the extent such limitation
  does not discriminate against out-of-state banks or bank holding companies.
  Individual states may also waive the 30% statewide concentration limit
  contained in the Act.

       Additionally, The federal banking agencies are authorized to approve
  interstate merger transactions without regard to whether such transaction is
  prohibited by the law of any state, unless the home state of one of the banks
  opts out of the Act by adopting a law, which applies equally to all out-of-
  state banks and expressly prohibits merger transactions involving out-of-state
  banks, after the date of enactment of the Act and prior to June 1, 1997. North
  Carolina has enacted legislation permitting interstate banking transactions.
  Interstate acquisitions of branches will be permitted only if the law of the
  state in which the branch is located permits such acquisitions. Interstate
  mergers and branch acquisitions will also be subject to the nationwide and
  statewide insured deposit concentration amounts described above.

       The Act authorizes the FDIC to approve interstate branching de novo by
  state banks only in states which specifically allow for such branching.
  Pursuant to the Riegle-Neal Act, the appropriate federal banking agencies have
  adopted regulations which prohibit any out-of-state bank from using the
  interstate branching authority primarily for the purpose of deposit
  production.  These regulations include guidelines to ensure that interstate
  branches operated by an out-of-state bank in a host state are reasonably
  helping to meet the credit needs of the communities which they serve.

       Dividends.  The Federal Reserve Board has issued a policy statement on
  the payment of cash dividends by bank holding companies, which expresses the
  Federal Reserve Board's view that a bank holding company should pay cash
  dividends only to the extent that the company's net income for the past year
  is sufficient to cover both the cash dividends and a rate of earning retention
  that is consistent with the company's capital needs, asset quality and overall
  financial condition.  The Federal Reserve Board also indicated that it would
  be inappropriate for a company experiencing serious financial problems to
  borrow funds to pay dividends.  Furthermore, under the prompt corrective
  action regulations adopted by the Federal Reserve Board pursuant to FDICIA,
  the Federal Reserve Board may prohibit a bank holding company from paying any
  dividends if the holding company's bank subsidiary is classified as
  "undercapitalized".  See "-- Depository Institution Regulation -- Prompt
  Corrective Regulatory Action."

                                       81
Bank holding companies are required to give the Federal Reserve Board
  prior written notice of any purchase or redemption of its outstanding equity
  securities if the gross consideration for the purchase or redemption, when
  combined with the net consideration paid for all such purchases or redemptions
  during the preceding 12 months, is equal to 10% or more of the their
  consolidated retained earnings.  The Federal Reserve Board may disapprove such
  a purchase or redemption if it determines that the proposal would constitute
  an unsafe or unsound practice or would violate any law, regulation, Federal
  Reserve Board order, or any condition imposed by, or written agreement with,
  the Federal Reserve Board.  Bank holding companies whose capital ratios exceed
  the thresholds for "well-capitalized" banks on a consolidated basis are exempt
  from the foregoing requirement if they were rated composite 1 or 2 in their
  most recent inspection and are not the subject of any unresolved supervisory
  issues.

  FEDERAL SECURITIES LAW

       The Company has filed with the SEC a Registration Statement under the
  Securities Act of 1933, as amended (the "Securities Act"), for the
  registration of the common stock to be issued in the Stock Conversion.  Upon
  completion of the Stock Conversion, the common stock will be registered with
  the SEC under the Securities Exchange Act of 1934, as amended (the "Exchange
  Act").  The Company will then be subject to the information, proxy
  solicitation, insider trading restrictions and other requirements of the
  Exchange Act.

       The registration under the Securities Act of the common stock does not
  cover the resale of such shares.  Shares of the common stock purchased by
  persons who are not affiliates of the Company may be resold without
  registration.  Shares purchased by an affiliate of the Company will be subject
  to the resale restrictions of Rule 144 under the Securities Act.  If the
  Company meets the current public information requirements of Rule 144 under
  the Securities Act, each affiliate of the Company who complies with the other
  conditions of Rule 144 (including those that require the affiliate's sale to
  be aggregated with those of certain other persons) would be able to sell in
  the public market, without registration, a number of shares not to exceed, in
  any three-month period, the greater of (i) 1% of the outstanding shares of the
  Company or (ii) the average weekly volume of trading in such shares during the
  preceding four calendar weeks.  Provision may be made in the future by the
  Company to permit affiliates to have their shares registered for sale under
  the Securities Act under certain circumstances.  There are currently no demand
  registration rights outstanding.  However, in the event the Company at some
  future time determines to issue additional shares from its authorized but
  unissued shares, the Company might offer registration rights to certain of its
  affiliates who want to sell their shares.

                                   TAXATION

  GENERAL

       The Bank files a federal income tax return based on a fiscal year ending
  September 30.

  FEDERAL INCOME TAXATION

       Savings institutions such as the Bank are subject to the provisions of
  the Internal Revenue Code of 1986, as amended (the "Internal Revenue Code") in
  the same general manner as other corporations.  Through tax years beginning
  before December 31, 1995, institutions such as the Bank which met certain
  definitional tests and other conditions prescribed by the Internal Revenue
  Code benefitted from certain favorable provisions regarding their deductions
  from taxable income for annual additions to their bad debt reserve.  For
  purposes of the bad debt reserve deduction, loans are separated into
  "qualifying real property loans," which generally are loans secured by
  interests in certain real property, and "nonqualifying loans", which are all
  other loans.  The bad debt reserve deduction with respect to nonqualifying
  loans must be based on actual loss experience.  The amount of the bad debt
  reserve deduction with respect to qualifying real property loans may be based
  upon actual loss experience (the "experience method") or a percentage of
  taxable income determined without regard to such deduction (the "percentage of
  taxable income method").  Under the experience method, the bad debt deduction
  for an addition to the reserve for qualifying real property loans was an

                                       82
amount determined under a formula based generally on the bad debts actually
  sustained by a savings institution over a period of years.  Under the
  percentage of taxable income method, the bad debt reserve deduction for
  qualifying real property loans was computed as 8% of a savings institution's
  taxable income, with certain adjustments.  The Bank generally elected to use
  the method which has resulted in the greatest deductions for federal income
  tax purposes in any given year.

       Legislation that is effective for tax years beginning after December 31,
  1995 requires institutions to recapture into taxable income over a six taxable
  year period the portion of the tax loan reserve that exceeds the pre-1988 tax
  loan loss reserve.  As a result of changes in the law, saving institutions
  were required to change to either the reserve method or the specific charge-
  off method that applied to banks.

       The Bank is not required to provide a deferred tax liability for the tax
  effect of additions to the tax bad debt reserve through 1987, the base year.
  Retained income at September 30, 1998 includes approximately $4.2 million for
  which no provision for federal income tax has been made.  These amounts
  represent allocations of income to bad debt deductions for tax purposes only.
  Reduction of such amounts for purposes other than tax bad debt losses could
  create income for tax purposes in certain remote instances, which would be
  subject to the then current corporate income tax rate.

       The Bank's federal income tax returns have not been audited since 1993.

       For additional information, see "Management's Discussion and Analysis of
  Financial Condition and Results of Operations -- Impact of New Accounting
  Standards" and the financial statements and related notes appearing elsewhere
  herein.

  STATE INCOME TAXATION

       Under North Carolina law, the corporate income tax currently is 7.25% of
  federal taxable income as computed under the Internal Revenue Code, subject to
  certain prescribed adjustments.  This rate will be reduced to 7.00% for 1999
  and 6.9% for 2000 and thereafter.  In addition, for tax years beginning in
  1991, 1992, 1993 and 1994, corporate taxpayers were required to pay a surtax
  equal to 4%, 3%, 2% and 1%, respectively, of the state income tax otherwise
  payable.  An annual state franchise tax is imposed at a rate of .15% 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)
  appraised valuation of property in North Carolina.

       For additional information regarding taxation, see Notes 1 and 10 of the
  Notes to the Financial Statements.

                           MANAGEMENT OF THE COMPANY

       The Board of Directors of the Company consists of the same individuals
  who serve as directors of the Bank.  Their biographical information is set
  forth under "Management of the Bank -- Directors."  The Board of Directors of
  the Company is divided into three classes.  Directors of the Company will
  serve for three year terms or until their successors are elected and
  qualified, with approximately one-third of the directors being elected at each
  annual meeting of stockholders, beginning with the first annual meeting of
  stockholders following the Stock Conversion.  Directors Bean, McGill and
  Stadler have terms of office expiring at the 2000 annual meeting, Directors
  Barnwell, McClure and Quakenbush have terms of office expiring at the 2001
  annual meeting, and Directors Keziah and Shirley have terms of office expiring
  at the 2002 annual meeting.  Under the Company's bylaws, a person who is 75
  years of age  or older and who is not an employee of the Company or the Bank
  shall not be eligible for election, re-election, appointment, or re-
  appointment to the Board of Directors, and a non-employee director shall not
  serve beyond the annual meeting of the Company immediately following the non-
  employee director becoming 75.

                                       83
The following individuals hold the offices in the Company set forth below
  opposite their names.

       Name                      Title
       ----                      -----
       James C. McGill           President and Chief Executive Officer
       A. Christine Baker        Treasurer and Secretary
       Fairfax C. Reynolds       Vice President and Assistant Secretary

       The executive officers of the Company are elected annually and hold
  office until their respective successors have been elected and qualified or
  until death, resignation or removal by the Board of Directors of the Company.

       Since the formation of the Company, none of the executive officers,
  directors or other personnel have received remuneration from the Company.
  Information concerning the principal occupations and employment of the
  directors and executive officers of the Company during the past five years is
  set forth under "Management of the Bank -- Directors" and "-- Executive
  Officers Who Are Not Directors."  Executive officers and directors of the
  Company will be compensated as described below under "Management of the Bank."

                             MANAGEMENT OF THE BANK

  DIRECTORS

       Because we are a mutual savings bank, our members have elected our Board
  of Directors.  Upon completion of the Stock Conversion, the directors of the
  Bank immediately prior to the Stock Conversion will continue to serve as
  directors of the Converted Bank.  Currently, the term of each director is one
  year, and all of the members of the Board of Directors stand for election each
  year.  This will continue to be the case for the Converted Bank following the
  Bank Conversion.  Because the Company will own all the issued and outstanding
  capital stock of the Converted Bank following the Conversion, the Board of
  Directors of the Company will elect the directors of the Converted Bank.

       The following table sets forth certain information with respect to the
  individuals who serve currently as members of our Board of Directors.  There
  are no arrangements or understandings between the Bank and any director
  pursuant to which such person has been elected a director of the Bank, and no
  director is related to any other director or executive officer by blood,
  marriage or adoption.  All directors' terms expire in December 1999.

                               AGE AT
                            SEPTEMBER 30,
  NAME                            1998       DIRECTOR SINCE
  -----                     -------------    --------------
 
  James A. Barnwell, Jr.          58            1988
  Bernie C. Bean                  68            1978
  Richard C. Keziah               66            1983
  James G. McClure                53            1989
  James C. McGill                 57            1988
  T. Scott Quakenbush             67            1978
  Richard H. Shirley              51            1987
  Virgil L. Stadler               62            1982
 

                                       84
Presented below is certain information concerning the directors of the
  Bank.  Unless otherwise stated, all directors have held the positions
  indicated for at least the past five years.

       JAMES A. BARNWELL, JR. is president of Huffman Oil Co., Inc., a petroleum
  marketer in Burlington, North Carolina.  He has served on the advisory board
  of the Salvation Army Boys & Girls Club and the YMCA board.

       BERNIE C. BEAN is retired.  From 1988 to 1995 he was the national sales
  manager of Craftique, Inc., a furniture manufacturer located in Mebane, North
  Carolina.

       RICHARD C. KEZIAH is president of Monarch Hosiery Mills, Inc. in
  Burlington, North Carolina.  He also serves on the board of directors of Elon
  Homes for Children.

       JAMES G. MCCLURE is president of Green & McClure, a retail furniture
  store in Graham, North Carolina.  He has served as president of the Graham
  Area  Business Association, on the zoning board for the city of Graham and is
  an Elder at the Graham Presbyterian Church.

       JAMES C. MCGILL has been President and Chief Executive Officer of the
  Bank since December 1988.  He serves on the Boards of Hospice of Alamance and
  Alamance Community College and in 1997 served as the chairman of the North
  Carolina Bankers Association.

       T. SCOTT QUAKENBUSH retired in April 1997 from his position as vice
  president and sales manager with Carolina Paper Box Company in Burlington,
  North Carolina.

       RICHARD H. SHIRLEY is president of Dick Shirley Chevrolet, Inc., an
  automobile dealership located in Burlington, North Carolina.  He has served as
  the president of the Alamance County YMCA and as a member and chairman of the
  Economic Development Committee of the Burlington area Chamber of Commerce.

       VIRGIL L. STADLER is the vice president of Stadler Country Hams, Inc. in
  Elon College, North Carolina.  He is active with the ACC Foundation, Elon
  Homes for Children and the Burlington area Chamber of Commerce.

  EXECUTIVE OFFICERS WHO ARE NOT DIRECTORS

       The following sets forth information with respect to executive officers
  of the Bank who do not serve on the Board of Directors.
AGE AT
                         SEPTEMBER 30,
  NAME                       1998             TITLE WITH THE BANK 
  ----                  -------------        ---------------------
A. Christine Baker       45                 Executive Vice President - Chief Financial Officer,
                                              Secretary and Treasurer
  Fairfax C. Reynolds      45                 Executive Vice President - Commercial and Retail
                                              Banking
  Frank Gavigan            40                 Senior Vice President - Senior Credit Officer
  John D. Hansell          61                 Manager - First Capital Services, LLC
A. CHRISTINE BAKER has served as Executive Vice President, Secretary and
  Treasurer of the Bank since April 1985.  She has served as president and
  director of the Burlington Rotary Club, director and treasurer of the local
  chapter of the American Red Cross and director and vice president of the
  Childcare Resource and Referral Service.

                                       85
FAIRFAX C. REYNOLDS has served as Executive Vice President in charge of
  Retail and Commercial Banking of the Bank since 1989.  He serves on the Board
  of Directors of YMCA of Alamance County, the Alamance County Arts Council, the
  Alamance County Area Chamber of Commerce and the Alamance Country Club.  He is
  an Elder of the First Presbyterian Church.

       FRANK GAVIGAN has served as Senior Vice President - Senior Credit Officer
  of the Bank since 1990.  He has served as the budget director and on the
  executive committee of the United Way, as Vice President and a director of
  Alamance County Meals on Wheels, as President and a director of Alamance
  Prevention Alliance and on the finance committee of Front Street United
  Methodist Church.

       JOHN D. HANSELL has served since May 1987 as Manager of 1st Capital
  Services Company, LLC and its predecessor, First Capital Services, Inc.,
  entities owned by the Bank that sell annuities, mutual funds and insurance
  products on an agency basis.  He has served on the small business council of
  the Alamance Chamber of Commerce and on the board of directors of the
  International Association of Financial Planners.

  COMMITTEES OF THE BOARD OF DIRECTORS

       Our Board of Directors meets monthly and may have additional special
  meetings.  During the year ended September 30, 1998, the Board met 12 times.
  No director attended fewer than 75% in the aggregate of the total number of
  Board meetings held during the year ended September 30, 1998 and the total
  number of meetings held by committees on which he served during such fiscal
  year.  The Board of Directors has standing Audit and Executive Committees.

       The Board of Directors' Audit Committee consists of Directors Keziah,
  Quakenbush and Stadler, who serves as Chairperson.  The Audit Committee met
  one time during the year ended September 30, 1998.  The function of the Audit
  Committee is to examine and approve the audit report prepared by the
  independent auditors of the Bank, to review and recommend the independent
  auditors to be engaged by the Bank, to review the internal audit function and
  internal accounting controls, and to review and approve audit policies.

       The Board of Directors' Executive Committee consists of Directors McGill,
  Barnwell, Shirley and Keziah and one additional director who serves on a
  rotating basis for a three-month period.  The Executive Committee, among other
  things, evaluates the compensation and benefits of the directors, officers and
  employees, recommends changes, and monitors and evaluates employee
  performance.  The Executive Committee reports its evaluations and findings to
  the full Board of Directors and all compensation decisions are ratified by the
  full Board of Directors.  Directors of the Bank who also are officers of the
  Bank abstain from discussion and voting on matters affecting their
  compensation. The Executive Committee also monitors the performance of the
  Bank's investment portfolio and reviews loans. The Executive Committee is
  empowered to exercise all of the authority of the Board when the Board is not
  in session. The Executive Committee met 12 times during the fiscal year ended
  September 30, 1998.

                                       86
EXECUTIVE COMPENSATION

       The following table sets forth the cash and noncash compensation for the
  last fiscal year awarded to or earned by the President and the four other
  executive officers of the Bank who earned salary and bonus in fiscal 1998
  exceeding $100,000 for services rendered in all capacities to the Bank.
Annual Compensation
                                   --------------------------------------------------
  Name and                         Fiscal                            Other Annual       All Other
  Principal Position               Year      Salary    Bonus         Compensation (1)  Compensation (2)
  ------------------               ----      ------    -----         ----------------  ----------------
James C. McGill                 1998      $175,000  $ 257,000          --              107,352
     President and Chief
     Executive Officer
 
  A. Christine Baker               1998        95,000    128,500          --               44,469
     Executive Vice President,
     Treasurer and Secretary
 
  Fairfax C. Reynolds              1998        95,000    128,500          --               44,476
     Executive Vice President
 
  Frank Gavigan                    1998        76,000     30,000          --               10,260
     Senior Vice President
 
  John D. Hansell                  1998        42,000     68,220  (3)     --                5,460
     Manager
---------------------
  (1)     Executive officers of the Bank receive indirect compensation in the
          form of certain perquisites and other personal benefits. The amount of
          such benefits received by the named executive officer in fiscal 1998
          did not exceed 10% of the executive officer's salary and bonus.

  (2)     Includes $4,800, $2,850, $2,850, $2,280 and $1,260 in matching
          contributions under the Bank's 401(k) Plan and $20,580, $10,830,
          $10,830, $7,980 and $4,200 in accruals made pursuant to the Bank's
          Money Purchase Pension Plan for executive officers McGill, Baker,
          Reynolds, Gavigan and Hansell, respectively. The Money Purchase
          Pension Plan was terminated effective September 30, 1998. Also
          includes $81,972, $30,789 and $33,766 accrued under our Deferred
          Compensation Plan for the benefit of executive officers McGill, Baker
          and Reynolds, respectively, for service as an employee during the year
          ended September 30, 1998. Does not include amounts accrued pursuant to
          such plan during the year ended September 30, 1998 for service in
          prior years.

  (3)     Consists of commissions.

          Employee Stock Ownership Plan.  We have established the ESOP for the
  exclusive benefit of our participating employees, to be implemented upon the
  completion of the Stock Conversion.  Participating employees are employees who
  have completed one year of service with us (including at least 1,000 hours of
  service) and have attained the age of 21.  An application for a letter of
  determination as to the tax-qualified status of the ESOP will be submitted to
  the IRS.  Although no assurances can be given, we expect that the ESOP will
  receive a favorable letter of determination from the IRS.

          The ESOP is to be funded by contributions made by us in cash or common
  stock.  Benefits may be paid either in shares of the common stock or in cash.
  In accordance with the Plan, the ESOP may borrow funds with which to acquire
  up to 8% of the common stock to be issued in the Stock Conversion.  The ESOP
  intends to borrow funds from the Company.  The loan is expected to be for a
  term of 10 years at an annual interest rate equal to the prime rate, adjusted
  annually on each October 1st.   Presently it is anticipated that the ESOP will
  purchase up to 8% of the common stock to be issued in the offering, including
  shares contributed to the Foundation (132,000 shares based on the midpoint of
  the Estimated Valuation Range and the contribution of 150,000 shares of common
  stock to the Foundation).  The loan will be secured by the shares purchased.
  Shares purchased with such loan proceeds will be held in a suspense account
 

                                       87
for allocation among participant accounts as the loan is repaid. We anticipate
contributing approximately $264,000 annually (based on a 132,000 share purchase)
to the ESOP to meet principal obligations under the ESOP loan, as proposed. It
is anticipated that all such contributions will be tax-deductible. This loan is
expected to be fully repaid in approximately 10 years.

     Contributions to the ESOP and shares released from the suspense account
will be allocated among participant accounts on the basis of each participant's
annual wages subject to federal income tax withholding, plus any amounts
withheld under a plan qualified under Section 125 or 401(k) of the Code and
sponsored by us. All participants must be employed at least 500 hours in a plan
year in order to receive an allocation. Participants will become 20% vested in
their ESOP account balances beginning in their third year for each year of
service, up to a maximum of 100% for seven years of service, with no more than
five years of service credited for employment before October 1, 1998. Vesting
will be accelerated upon retirement, death, disability, change in control of the
Company, or termination of the ESOP. Forfeitures will be reallocated to
participants on the same basis as other contributions in the plan year. Benefits
will be payable in the form of a lump sum upon retirement, death, disability or
separation from service. Our contributions to the ESOP are discretionary and may
cause a reduction in other forms of compensation. Therefore, benefits payable
under the ESOP cannot be estimated.

     In the event of a change in control of the Company, the outstanding balance
of any loans used to finance the purchase of shares by the ESOP will be paid off
through a transfer or sale of shares held as collateral under such loan, with
any remaining shares allocated to participant accounts pro rata based on their
account balances. Participants terminating employment on or after the change in
control will be entitled to receive a cash payment from the Company or its
successor equal to the amount, if any, which would have been allocated to the
participant's account immediately following the change in control but was
precluded from allocation based on allocation limits applicable under federal
tax laws.

     The board of directors has appointed non-employee directors to the ESOP
Committee to administer the ESOP and to serve as the initial ESOP Trustees. The
board of directors or the ESOP Committee may instruct the ESOP Trustees
regarding investments of funds contributed to the ESOP. The ESOP Trustees must
vote all allocated shares held in the ESOP in accordance with the instructions
of the participating employees. Unallocated shares and allocated shares for
which no timely direction is received will be voted by the ESOP Trustees as
directed by the Board of Directors or the ESOP Committee, subject to the
Trustees' fiduciary duties.

     401(k) Plan. Our 401(k) Plan is being amended in connection with the
Conversion to allow participants initially and on an ongoing basis to direct
that all or part of their account balances be invested in Company common stock.
Participants will retain the right to vote those shares held in trust for them
under the 401(k) Plan.

     Employment Agreements and Guaranty Agreements. The Bank has entered into
employment agreements (the "Employment Agreements") with James C. McGill, A.
Christine Baker and Fairfax C. Reynolds (each an "Employee, and, collectively,
the "Employees"). The Board believes that the Employment Agreements assure fair
treatment of the Employees in their careers with the Bank by assuring them of
some financial security. The proposed Employment Agreements will require FDIC
approval prior to becoming effective.

     The Employment Agreements will become effective on the date of completion
of the Stock Conversion and will provide for a term of three years, with an
annual base salary equal to the Employee's existing base salary rate in effect
on the date of Stock Conversion. On each anniversary date of the commencement of
the Employment Agreements, the term of the Employee's employment will be
extended for an additional one-year period beyond the then effective expiration
date upon a determination by the Bank's Board of Directors that the performance
of the Employee has met the required performance standards and that such
Employment Agreements should be extended. The Employment Agreements provide the
Employee with a salary review by the Board of Directors not less often than
annually, as well as with inclusion in any discretionary bonus plans, retirement
and medical plans, customary fringe benefits, vacation and sick leave. If the
Board decides not to renew an Employment Agreement for any reason, and if

                                       88
the Employee remains an employee of the Bank until the Agreement expires, the
Bank shall thereupon pay the Employee an amount equal to two times total
compensation.

     The Employment Agreements terminate upon the Employee's death, may
terminate upon the Employee's disability and is terminable by the Bank for "just
cause" (as defined in the Employment Agreements). In the event of termination
for just cause, no severance benefits are available. If the Bank terminates the
Employee without just cause, the Employee shall be entitled to receive three
times his total compensation as well as continued medical and dental insurance
under any group plan chosen by the Employee from the plans the Bank maintains,
unless that coverage is not permitted by the terms of such plan, whereby the
Bank shall remit to the Employee, not less frequently than monthly, the actual
cost to the Employee of equivalent insurance. These provisions shall be in
addition to, and not in lieu of, any other rights that the Employee has under
the Employment Agreement, and shall continue until the Employee first becomes
eligible for participation in Medicare. If the Employment Agreements are
terminated due to the Employee's "disability" (as defined in the Employment
Agreements), the Employee will be entitled to a continuation of his salary and
benefits through the date of such termination, including any period prior to the
establishment of the Employee's disability. In the event of the Employee's death
during the term of the Employment Agreements, his estate shall be entitled to
receive three times his total compensation determined as of the date of his
death. Each Employee is able to voluntarily terminate his or her Employment
Agreement by providing 90 days' written notice to the Board of Directors of the
Bank, in which case the Employee is entitled to receive only his or her
compensation, vested rights, and benefits up to the date of termination.

     In the event of (i) the Employee's involuntary termination of employment
other than for "just cause" during the period beginning six months before a
change in control and ending on the later of the first anniversary of the change
in control or the expiration date of the Employment Agreements (the "Protected
Period"), (ii) the Employee's voluntary termination within 90 days of the
occurrence of certain specified events occurring during the Protected Period
which have not been consented to by the Employee, or (iii) the Employee's
voluntary termination of employment for any reason within the 30-day period
beginning on the date of the change in control, the Bank shall (i) pay a
severance benefit equal to the difference between the product of 2.99 and the
Employee's "base amount" as defined in the Internal Revenue Code Section
280G(b)(3) and the sum of any other "parachute payments" as defined under Code
Section 280G(b)(2) that the Employee receives on account of the change in
control, and (ii) provide long-term disability and medical insurance for 18
months. The Employee shall be paid either (i) in one lump sum within ten days of
the later of the date of the change in control and the Employee's last day of
employment with the Bank or the Company, or (ii) if prior to the date which is
90 days before the date on which a change in control occurs, the Employee filed
a duly executed irrevocable written election, payment of such amount shall be
made according to the elected schedule. "Change in control" generally refers to
the acquisition, by any person or entity, of the ownership or power to vote more
than 25% of the Bank's or Company's voting stock, the control of the election of
a majority of the Bank's or the Company's directors, or the exercise of a
controlling influence over the management or policies of the Bank or the
Company. In addition, under the Employment Agreements, a change in control
occurs when, during any consecutive two-year period, directors of the Company or
the Bank at the beginning of such period cease to constitute two-thirds of the
Board of Directors of the Company or the Bank, unless the election of
replacement directors was approved by a two-thirds vote of the initial directors
then in office. The Employment Agreements provide that within 10 business days
of a change in control, the Bank shall deposit in a Trust an amount equal to the
Internal Revenue Code Section 280G maximum. The payments that would be made to
Mr. McGill, Ms. Baker and Mr. Reynolds assuming termination of employment under
the foregoing circumstances at September 30, 1998 would have been approximately
$1.1 million, $539,000 and $539,000, respectively. These provisions may have an
anti-takeover effect by making it more expensive for a potential acquiror to
obtain control of the Company. For more information, see "Certain Anti-Takeover
Provisions in the Articles of Incorporation and Bylaws -- Benefit Plans." In the
event that the Employee prevails over the Company and the Bank, or obtains a
written settlement, in a legal dispute as to the Employment Agreement, he or she
will be reimbursed for his legal and other expenses.

     In addition to the Employment Agreements, the Company has entered into
Guaranty Agreements with each of the Employees. The Guaranty Agreements provide
that the Company will perform all covenants and honor all

                                       89
obligations required to be performed or to which the Bank is subject pursuant to
the Employment Agreements in the event that such covenants are not performed or
obligations are not honored by the Bank, and that to the extent permitted by
law, the Company will be jointly and severally liable with the Bank for the
payment of all amounts due under the Employment Agreements. The Guarantee
Agreements provide the Employee with a salary review by the Board of Directors
not less often than annually, as well as with inclusion in any discretionary
bonus plans, retirement and medical plans, customary fringe benefits, vacation
and sick leave.

DIRECTOR COMPENSATION

     Fees. Each non-employee member of the Bank's Board of Directors receives a
monthly retainer fee based on the following schedule: the Chairman of the Board
 - $2,000; members of the Executive Committee - $1,750; and other directors -
$1,500. Officers who are directors are not compensated for their service as
directors. Directors also will participate in certain of our benefit plans. See
" -- Proposed Future Stock Benefit Plans."

     Deferred Compensation Plan. We adopted the 1st State Bank Deferred
Compensation Plan, effective September 24, 1997 for our directors and select
executive officers. Under the plan, before each fiscal year begins, each non-
employee director may elect to defer receipt of all or part of his future fees
and any other participant may elect to defer receipt of up to 25% of his or her
salary or 100% of his or her bonus compensation for the year. Deferred amounts
are credited at the end of the calendar year to bookkeeping accounts in the name
of each participant.

     Pursuant to the terms of the plan, the accounts of directors Barnwell,
Bean, Keziah, McClure, Quakenbush, Shirley and Stadler were credited, on the
plan's effective date, with $79,152, $70,672, $90,460, $62,819, $70,672, $79,152
and $70,672, respectively, with respect to prior years of service up to nine
years. On each September 30 after 1997, the Bank will credit the accounts of
directors Barnwell, Bean, Keziah, McClure, Quakenbush, Shirley, and Stadler with
$8,795, $7,852, $10,051, $7,852, $7,852, $8,795 and $7,852, respectively,
provided that such annual credits shall not be made for the benefit of non-
employee directors after 12 years of service credits. Similarly, the plan
provides supplemental executive retirement benefits for executive officers
McGill, Baker and Reynolds through initial credits of $737,729, $277,098 and
$270,126, respectively, on September 24, 1997 and, through annual credits, on
each September 30th after 1997, of $81,972, $30,789 and $33,766, respectively.
Each participant is fully vested in his account balance under the Plan.

     Until distributed in accordance with the terms of the plan, each
participant's account will be credited with a rate of return equal to our
highest rate of interest paid on our one-year certificates of deposit. On and
after the Conversion, each participant may prospectively elect to instead have
all or part of his account credited with the total return on the common stock.
Account balances will normally be distributed in five substantially equal annual
installments beginning during the first quarter of the calendar year following
the calendar year in which the participant ceases to be a director or employee,
with any subsequent payments being made by the last day of the first quarter of
each subsequent calendar year until the participant has received the entire
amount of his or her account. Participants may, however, elect to receive their
distributions in a lump sum or in installments paid over a period of up to 10
years. In the event of a participant's death, the balance of his plan account
will be paid in a lump sum (unless the participant elects to continue the
previously designated distribution method) to his designated beneficiary, or if
none, his estate.

     We have established a trust in order to hold assets with which to pay plan
benefits to participants. Trust assets are subject to claims of general
creditors. In the event a participant prevails over us in a legal dispute as to
the terms or interpretation of the plan, he or she would be reimbursed for his
legal and other expenses.

PROPOSED FUTURE STOCK BENEFIT PLANS

     Stock Option Plan. We intend to adopt a stock option plan (the "Option
Plan") following the Stock Conversion, subject to approval by the Company's
stockholders if required by applicable law. We currently expect to implement
this plan no sooner than one year after the Stock Conversion. However, the
Company may hold a stockholders' meeting

                                       90
as soon as six months after the Stock Conversion to adopt the Option Plan. If
the Option Plan is adopted during the first year following the Stock Conversion,
the Option Plan would be in compliance with the FDIC conversion regulations in
effect. See "--Restrictions on Stock Benefit Plans." If the Option Plan is
implemented more than one year after the Stock Conversion, which we expect, the
Option Plan will comply with FDIC regulations and policies that are applicable
at such time. If the Option Plan is implemented within one year after the Stock
Conversion, in accordance with FDIC regulations, a number of shares equal to 10%
of the aggregate shares of common stock to be issued in the Offering, including
shares contributed to the Foundation (i.e., 165,000 shares based upon the
issuance of 1,500,000 shares at the midpoint of the Estimated Valuation Range
and the contribution of 150,000 shares of common stock to the Foundation) would
be reserved for issuance by the Company upon exercise of stock options to be
granted to our officers, directors and employees from time to time under the
Option Plan. The purpose of the Option Plan would be to provide additional
performance and retention incentives to certain officers, directors and
employees by facilitating their purchase of a stock interest in the Company.
Under the FDIC regulations, the Option Plan would provide for a term of 10 years
after which no awards could be made, unless earlier terminated by the Board of
Directors pursuant to the Option Plan. The options would vest over a five year
period (i.e., 20% per year), beginning on the date of grant of the option, if
the Option Plan is implemented within one year of the Stock Conversion. Options
would expire no later than 10 years from the date granted and would expire
earlier if the Option Committee so determines or in the event of termination of
employment. Options would be granted based upon several factors, including
seniority, job duties and responsibilities, job performance, our financial
performance and a comparison of awards given by other savings institutions
converting from mutual to stock form.

       The Company would receive no monetary consideration for the granting of
stock options under the Option Plan. It would receive the option exercise price
for each share issued to optionees upon the exercise of such options. Shares
issued as a result of the exercise of options will be either authorized but
unissued shares or shares purchased in the open market by the Company. The
exercise of options and payment for the shares received would contribute to the
equity of the Company.

       Management Recognition Plan.  We intend to adopt the MRP following the
Stock Conversion, the objective of which is to enable us to retain personnel and
directors of experience and ability in key positions of responsibility. We
expect to implement the MRP no sooner than one year after the Stock Conversion
(subject to any stockholder approval required by law), but may elect instead to
hold a stockholders' meeting as early as six months after the Stock Conversion.
If the MRP is implemented within one year or more after the Stock Conversion, in
accordance with applicable FDIC regulations, the shares granted under the MRP
will be in the form of restricted stock vesting over a five- year period (i.e.,
20% per year) beginning one year after the date of grant of the award.
Additionally, the number of shares to be granted could not exceed 4% of the
shares sold in the Stock Conversion, including shares contributed to the
Foundation, if the MRP is adopted during the first year following Stock
Conversion. If the MRP is implemented more than one year after the Stock
Conversion, the MRP will comply with such FDIC regulations and policies that are
applicable at such time. Compensation expense in the amount of the fair market
value of the common stock granted will be recognized pro rata over the years
during which the shares are payable. Until they have vested, such shares may not
be sold, pledged or otherwise disposed of and are required to be held in escrow.
Any shares not so allocated would be voted by the MRP Trustees. Awards would be
granted based upon a number of factors, including seniority, job duties and
responsibilities, job performance, our performance and a comparison of awards
given by other institutions converting from mutual to stock form. The MRP would
be managed by a committee of non-employee directors (the "MRP Trustees"). The
MRP Trustees would have the responsibility to invest all funds contributed by us
to the trust created for the MRP (the "MRP Trust").

       We expect to contribute sufficient funds to the MRP so that the MRP Trust
can purchase, in the aggregate, up to 4% of the amount of common stock that is
sold in the Stock Conversion, including shares contributed to the Foundation.
The shares purchased by the MRP would be authorized but unissued shares or would
be purchased in the open market. Whether such shares will be purchased in the
open market or newly issued of the Company, and the timing of such purchases,
will depend on market and other conditions and the alternative uses of capital
available to the Company. In the event the market price of the common stock is
greater than $20.00 per share when awards are made,

                                       91
our contribution of funds will be increased. Likewise, in the event the market
price is lower than $20.00 per share, our contribution will be decreased. In
recognition of their prior and expected services to us and the Company, as the
case may be, the officers, other employees and directors responsible for
implementation of the policies adopted by the Board of Directors and our
profitable operation will, without cost to them, be awarded stock under the MRP.
Based upon the issuance of 1,500,000 shares of common stock in the Offering at
the midpoint of the Estimated Valuation Range and the contribution of 150,000
shares of common stock to the Foundation, the MRP Trust is expected to purchase
up to 66,000 shares of common stock.

       Restrictions on Stock Benefit Plans.  FDIC regulations provide that in
the event we implement stock option or management and/or employee stock benefit
plans within one year from the date of conversion, such plans must comply with
the following restrictions: (i) the plans must be fully disclosed in the
prospectus; (ii) all plans must be approved by a majority of the total votes
eligible to be cast at any duly called meeting of the Company's stockholders
held no earlier than six months following the Stock Conversion; (iii) for stock
option plans, the exercise price must be at least equal to the market price of
the stock at the time of grant; and (iv) for restricted stock plans such as the
MRP, no stock issued in a conversion may be used to fund the plan. In addition,
the FDIC presumes that a stock option plan or management recognition plan that
does not conform to applicable Office of Thrift Supervision ("OTS") percentage
limitations constitutes excessive insider benefits. Such percentage limitations
are: (i) for stock option plans, the total number of shares for which options
may be granted may not exceed 10% of the shares issued in the conversion,
including shares issued to a charitable foundation; (ii) for restricted stock
plans such as the MRP, the shares may not exceed 3% of the shares issued in the
conversion, including shares issued to a charitable foundation (4% for
institutions with 10% or greater tangible capital); (iii) the aggregate amount
of stock purchased by the ESOP in the conversion may not exceed 10% (12% for
well-capitalized institutions utilizing a 4% management recognition plan) of the
shares issued in the conversion, including shares issued to a charitable
foundation; (iv) no individual employee may receive more than 25% of the
available awards under the option plan or the MRP; (v) directors who are not
employees may not receive more than 5% individually or 30% in the aggregate of
the awards under any plan; and (vi) neither stock option awards nor restricted
stock awards may vest earlier than 20% as of one year after the date of
stockholder approval and 20% per year thereafter, and vesting may be accelerated
only in the case of disability or death (or if not inconsistent with applicable
FDIC regulations in effect at such time, in the event of a change in control).

TRANSACTIONS WITH MANAGEMENT

       We offer loans to our directors and officers.  These loans were made in
the ordinary course of business on substantially the same terms, including
interest rates and collateral, as those prevailing at the time for comparable
transactions with other persons and did not involve more than the normal risk of
collectibility or present other unfavorable features. Under current law, our
loans to directors and executive officers are required to be made on
substantially the same terms, including interest rates, as those prevailing for
comparable transactions with other persons and must not involve more than the
normal risk of repayment or present other unfavorable features. Furthermore, all
loans to such persons must be approved in advance by a disinterested majority of
our Board of Directors. At September 30, 1998, our loans to our directors and
executive officers and their affiliates totaled $7.5 million, or 29.0% of our
net worth, at that date. See Note 3 of Notes to Consolidated Financial
Statements.

                    CERTAIN RESTRICTIONS ON ACQUISITION OF
                      THE COMPANY AND THE CONVERTED BANK

CONVERSION REGULATIONS

       Applicable North Carolina regulations provide that for a period of three
years following the Stock Conversion, the prior written approval of the
Administrator will be required before any person may, directly or indirectly,
acquire beneficial ownership of or make any offer to acquire any stock or other
equity security of the Company if, after the acquisition or consummation of such
offer, such person would be the beneficial owner of more than 10% of such class

                                       92
of stock or other class of equity security of the Company. If any person were to
so acquire the beneficial ownership of more than 10% of any class of any equity
security without prior written approval, the securities beneficially owned in
excess of 10% would not be counted as shares entitled to vote and would not be
voted or counted as voting shares in connection with any matter submitted to
stockholders for a vote. Approval is not required for (i) any offer with a view
toward public resale made exclusively to the Company or its underwriters or the
selling group acting on its behalf or (ii) any offer to acquire or acquisition
of beneficial ownership of more than 10% of the common stock of the Company by a
corporation whose ownership is or will be substantially the same as the
ownership of the Company, provided that the offer or acquisition is made more
than one year following the consummation of the Stock Conversion. The regulation
provides that within one year following the Stock Conversion, the Administrator
would approve the acquisition of more than 10% of beneficial ownership only to
protect the safety and soundness of the institution. During the second and third
years after the Stock Conversion, the Administrator may approve such an
acquisition upon a finding that (i) the acquisition is necessary to protect the
safety and soundness of the Company and the Bank or the Board of Directors of
the Company and the Bank support the acquisition and (ii) the acquiror is of
good character and integrity and possesses satisfactory managerial skills, the
acquiror will be a source of financial strength to the Company and the Bank and
the public interests will not be adversely affected.

CHANGE IN BANK CONTROL ACT AND BANK HOLDING COMPANY ACT

       The Change in Bank Control Act, together with North Carolina regulations,
require that the consent of the Administrator and Federal Reserve Board be
obtained prior to any person or company acquiring "control" of a North Carolina-
chartered savings bank or a North Carolina-chartered savings bank holding
company. The consent of the Commission and the Federal Reserve Board is required
to be obtained prior to any person or company acquiring "control" of a North
Carolina-chartered commercial bank. Upon acquiring control, such acquiror will
be deemed to be a bank holding company. Control is conclusively presumed to
exist if, among other things, an individual or company acquires the power,
directly or indirectly, to direct the management or policies of the Company or
the Bank or to vote 25% or more of any class of voting stock. Control is
rebuttably presumed to exist under the Change in Bank Control Act if, among
other things, a person acquires more than 10% of any class of voting stock, and
the issuer's securities are registered under Section 12 of the Exchange Act or
the person would be the single largest stockholder. Restrictions applicable to
the operations of bank holding companies and conditions imposed by the Federal
Reserve Board in connection with its approval of such acquisitions may deter
potential acquirors from seeking to obtain control of the Company. See
"Regulation -- Regulation of the Company Following the Bank Conversion."

VIRGINIA STOCK CORPORATION ACT

       The Virginia Stock Corporation Act ("VSCA") contains a statute designed
to provide Virginia corporations with additional protections against hostile
takeovers. The Virginia Affiliated Transactions Act restricts certain
transactions between a Virginia corporation and a holder of 10% or more of the
corporation's outstanding voting stock, together with affiliates or associates
thereof (an "Interested Shareholder"). For a period of three years following the
date that a stockholder becomes an Interested Shareholder, the Virginia
Affiliates Transactions Act generally prohibits the following types of
transactions between the corporation and the Interested Shareholder (unless
certain conditions, described below, are met): (i) mergers; (ii) sales, leases,
exchanges, mortgages, pledges, transfers or other dispositions (in one or a
series of transactions) having a total market value in excess of 5% of the
corporation's consolidated net worth; (iii) any guarantees of indebtedness of
any Interested Shareholder in an amount in excess of 5% of the corporation's
consolidated net worth; (iv) sales or other dispositions by the corporation or
any subsidiary thereof of any voting shares of the corporation or any subsidiary
thereof having a market value of 5% or more of the total market value of the
outstanding voting shares of the corporation to any Interested Stockholder or
affiliate of any Interested Stockholder other than pursuant to a stock dividend
or the exercise of rights or warrants; (v) the dissolution of the corporation if
proposed by or on behalf of an Interested Stockholder; (vi) any reclassification
of securities, including any reverse stock split, or recapitalization of the
corporation, or any merger of the corporation with any of its subsidiaries or
any distribution or other transaction which has the effect directly or
indirectly of increasing by more than 5% the percentage of the outstanding
voting shares of the corporation or any of its subsidiaries beneficially owned
by

                                       93
any Interested Shareholder; and (vii) any share exchange in which an Interested
Shareholder acquires a class or series of the corporation's voting stock, unless
the affiliated transaction is approved by (a) a majority of the disinterested
directors, and (b) two-thirds of the disinterested voting shares. Additionally,
after the three-year prohibition on affiliated transactions has expired, an
affiliated transaction must be approved by two-thirds of the votes cast by
disinterested stockholders.

       The foregoing voting requirements do not apply if the particular
affiliated transaction (i) has been approved by a majority of the disinterested
directors; (ii) meets the rigorous fair price requirements of the Virginia
Affiliated Transactions Act; or (iii) qualifies for one of the statutory
exemptions. A Virginia corporation may exempt itself from the requirements of
the statute in its articles of incorporation. In this regard, the Company has
not exempted itself from the provisions of the Virginia Affiliated Transactions
Act. Additionally, the Virginia Affiliated Transactions Act does not apply to
corporations with less than 300 shareholders of record.

       The Virginia Control Share Acquisitions Act prohibits voting rights of
common stock of any person who acquires either (i) one-fifth or more, but less
than one-third, of all voting power of the corporation; (ii) one-third or more,
but less than a majority, of the voting power of the corporation; or (iii) a
majority or more of the voting power of the corporation, unless such person has
delivered an acquiring person's statement to the corporation, and such voting
rights are approved by a majority of the disinterested shares of stock eligible
to vote on the election of directors. A Virginia corporation may include a
provision in its articles of incorporation or bylaws exempting the corporation
from Virginia's Control Share Acquisitions Statute. The Company, however, has
not exempted itself from the provisions of Virginia's Control Share Acquisitions
Statute. In addition, Virginia's Control Share Acquisitions Statute does not
apply to corporations with less than 300 shareholders.

                       CERTAIN ANTI-TAKEOVER PROVISIONS
                  IN THE ARTICLES OF INCORPORATION AND BYLAWS

       While the Boards of Directors of the Company and the Bank are not aware
of any effort that might be made to obtain control of the Company after the
Conversion, the Company's Board of Directors, as discussed below, believes that
it is appropriate to include certain provisions as part of the Company's
Articles of Incorporation to protect the interests of the Company and its
stockholders from hostile takeovers which the Board of Directors might conclude
are not in the best interests of the Converted Bank, the Company or the
Company's stockholders. These provisions may have the effect of discouraging a
future takeover attempt which is not approved by the Board of Directors but
which individual stockholders may deem to be in their best interests or in which
stockholders may receive a substantial premium for their shares over then
current market prices. As a result, stockholders who might desire to participate
in such a transaction may not have an opportunity to do so. Such provisions also
will render the removal of the current Board of Directors or management of the
Company more difficult.

       The following discussion is a general summary of certain provisions of
the Articles of Incorporation and Bylaws of the Company which may be deemed to
have such an "anti-takeover" effect. The description of these provisions is
necessarily general and reference should be made in each case to the Articles of
Incorporation and Bylaws of the Company. For information regarding how to obtain
a copy of these documents without charge, see "Additional Information."

CLASSIFIED BOARD OF DIRECTORS AND RELATED PROVISIONS

       The Company's Articles of Incorporation provide that the Board of
Directors is to be divided into three classes which shall be as nearly equal in
number as possible. The directors in each class will hold office following their
initial appointment to office for terms of one year, two years and three years,
respectively, and, upon reelection, will serve for terms of three years
thereafter. Each director will serve until his or her successor is elected and
qualified. The Articles

                                       94
of Incorporation provide that a director may be removed only for cause and only
by the affirmative vote of the holders of at least 80% of the outstanding shares
entitled to vote.

       A classified Board of Directors could make it more difficult for
stockholders, including those holding a majority of the outstanding shares, to
force an immediate change in the composition of a majority of the Board of
Directors. Since the terms of only one-third of the incumbent directors expire
each year, it requires at least two annual elections for the shareholders to
change a majority, whereas a majority of a non-classified board may be changed
in one year. In the absence of the provisions of the Articles of Incorporation
classifying the Board, all of the directors would be elected each year.

       Management of the Company believes that the staggered election of
directors tends to promote continuity of management because only one-third of
the Board of Directors is subject to election each year. Staggered terms
guarantee that in the ordinary course approximately two-thirds of the Directors,
or more, at any one time have had at least one year's experience as Directors of
the Company, and moderate the pace of changes in the Board of Directors by
extending the minimum time required to elect a majority of Directors from one to
two years.

STOCKHOLDER VOTE REQUIRED TO APPROVE BUSINESS COMBINATIONS WITH PRINCIPAL
STOCKHOLDERS

       The Company's Articles of Incorporation require the approval of the
holders of (i) at least 80% of the Company's outstanding shares of voting stock,
and (ii) at least a majority of the Company's outstanding shares of voting
stock, not including shares deemed beneficially owned by a "Related Person," to
approve certain "Business Combinations" as defined in the Articles of
Incorporation, and related transactions. Under Virginia law, in addition to this
provision, Business Combinations would be subject to the Virginia Affiliated
Transactions Act and, subject to certain exceptions, must be approved by the
vote of the holders of at least a two-thirds of the outstanding disinterested
shares of common stock. For a discussion of the Virginia statutory voting and
other requirements, see "Certain Restrictions on Acquisition of the Company and
the Converted Bank -- Virginia Stock Corporation Act." The increased voting
requirements in the Company's Articles of Incorporation apply in connection with
business combinations involving a "Related Person," except in cases where the
proposed transaction has been approved in advance by two-thirds of those members
of the Company's Board of Directors who are unaffiliated with the Related Person
and who were directors prior to the time when the Related Person became a
Related Person (the "Continuing Directors"). The term "Related Person" is
defined to include any individual, corporation, partnership or other entity or
affiliate thereof which owns beneficially or controls, directly or indirectly,
10% or more of the outstanding shares of common stock of the Company. A
"Business Combination" is defined to include (i) any merger or consolidation of
the Company with or into a Related Person; (ii) any sale, lease exchange,
transfer, or other disposition of all or a substantial part of the assets of the
Company or of a subsidiary to a Related Person (the term "substantial part" is
defined to include more than 25% of the Company's total assets); (iii) any
merger or consolidation of a Related Person with or into the Company or a
subsidiary of the Company; (iv) any sale, lease, exchange, transfer or other
disposition of all or any substantial part of the assets of a Related Person to
the Company or a subsidiary of the Company; (v) the issuance of any securities
of the Company or a subsidiary of the Company to a Related Person; (vi) the
acquisition by the Company or a subsidiary of the Company of any securities of
the Related Person; (vii) any reclassification of the common stock, or any
recapitalization involving the common stock; and (viii) any agreement, contract
or other arrangement providing for any of the above transactions.

LIMITATIONS ON CALL OF MEETINGS OF STOCKHOLDERS

       The Company's Articles of Incorporation provide that special meetings of
stockholders may only be called by the Company's Board of Directors, President
or an appropriate committee appointed by the Board of Directors. Stockholders
are not authorized to call a special meeting, and stockholder action may be
taken only at a special or annual meeting of stockholders or if a consent in
writing setting forth the action taken is signed by all of the stockholders
entitled to vote on the matter.

                                       95
ABSENCE OF CUMULATIVE VOTING

       The Company's Articles of Incorporation provide that there shall not be
cumulative voting by stockholders for the election of the Company's directors.
The absence of cumulative voting rights effectively means that the holders of a
majority of the shares voted at a meeting of stockholders may, if they so
choose, elect all directors of the Company to be elected at that meeting, thus
precluding minority stockholder representation on the Company's Board of
Directors.

RESTRICTIONS ON ACQUISITIONS OF SECURITIES

       The Articles of Incorporation provide that for a period of three years
from the effective date of the Stock Conversion, no person may directly or
indirectly offer to acquire or acquire the beneficial ownership of more than 10%
of any class of the equity security of the Company, unless such offer or
acquisition shall have been approved in advance by a two-thirds vote of the
Company's Continuing Directors. This provision does not apply to any employee
stock benefit plan of the Company or to an underwriter or member of an
underwriting or selling group involving the public sale or resale of securities
of the Company or a subsidiary thereof; provided, that upon completion of the
sale or resale, no such underwriter or member of the selling group is a
beneficial owner of more than 10% of any class of equity securities of the
Company. In addition, during such three-year period, no shares beneficially
owned in violation of the foregoing percentage limitation, as determined by the
Company's Board of Directors, shall be entitled to vote in connection with any
matter submitted to stockholders for a vote. Additionally, the Articles of
Incorporation provide for further restrictions on voting rights of shares owned
in excess of 10% of any class of equity security of the Company beyond three
years after the Stock Conversion. Specifically, the Articles of Incorporation
provide that if, at any time after three years from the Bank's conversion to
stock form, any person acquires the beneficial ownership of more than 10% of any
class of equity security of the Company, then, with respect to each vote in
excess of 10%, the record holders of voting stock of the Company beneficially
owned by such person shall be entitled to cast only one-hundredth of one vote
with respect to each vote in excess of 10% of the voting power of the
outstanding shares of voting stock of the Company which such record holders
would otherwise be entitled to cast without giving effect to the provision, and
the aggregate voting power of such record holders shall be allocated
proportionately among such record holders. An exception from the restriction is
provided if the acquisition of more than 10% of the securities received the
prior approval by a two-thirds vote of the Company's Continuing Directors. Under
the Company's Articles of Incorporation, the restriction on voting shares
beneficially owned in violation of the foregoing limitations is imposed
automatically. In order to prevent the imposition of such restrictions, the
Board of Directors must take affirmative action approving in advance a
particular offer to acquire or acquisition. Unless the Board took such
affirmative action, the provision would operate to restrict the voting by
beneficial owners of more than 10% of the Company's common stock in a proxy
contest.

BOARD CONSIDERATION OF CERTAIN NONMONETARY FACTORS IN THE EVENT OF AN OFFER BY
ANOTHER PARTY

       The Articles of Incorporation of the Company permit the Board of
Directors, in evaluating a Business Combination or a tender or exchange offer,
to consider, in addition to the adequacy of the amount to be paid in connection
with any such transaction, certain specified factors and any other factors the
Board deems relevant, including (i) the social and economic effects of the
transaction on the Company and its subsidiaries, employees, depositors, loan and
other customers, creditors and other elements of the communities in which the
Company and its subsidiaries operate or are located; (ii) the business and
financial condition and earnings prospects of the acquiring person or entity;
and (iii) the competence, experience and integrity of the acquiring person or
entity and its or their management. By having the standards in the Articles of
Incorporation of the Company, the Board of Directors may be in a stronger
position to oppose any proposed Business Combination or tender or exchange offer
if the Board concludes that the transaction would not be in the best interest of
the Company, even if the price offered is significantly greater than the then
market price of any equity security of the Company.

       The Board of Directors feels a responsibility for maintaining the
financial and business integrity of the Company. Savings institutions and banks
and their holding companies occupy positions of special trust in the

                                       96
communities they serve. They also provide opportunities for abuse by those who
are not of sufficient experience or competence or financial means to act
professionally and responsibly with respect to management of a financial
institution. It is of concern to the Company that it be managed in the interest
of the communities that it serves and that it and its subsidiary bank maintain
their integrity as institutions.

       One effect of this provision might be to encourage consultation by an
offeror with the Board of Directors prior to or after commencing a tender offer
in an attempt to prevent a contest from developing. This provision thus may
strengthen the Board of Directors' position in dealing with any potential
offeror which might attempt to effect a takeover of the Company. The provision
will not make a Business Combination regarded by the Board of Directors as being
in the interests of the Company more difficult to accomplish, but it will permit
the Board of Directors to determine whether a Business Combination or tender or
exchange offer is not in the interests of the Company (and thus to oppose it) on
the basis of various factors deemed relevant.

AUTHORIZATION OF PREFERRED STOCK

       The Company's Articles of Incorporation authorize the issuance of up to
1,000,000 shares of preferred stock, which conceivably could represent an
additional class of stock required to approve any proposed acquisition. The
Company is authorized to issue preferred stock from time to time in one or more
series subject to applicable provisions of law, and the Board of Directors is
authorized to fix the powers, designations, preferences and relative,
participating, optional and other special rights of such shares, including
voting rights and conversion rights. Issuance of the preferred stock could
adversely affect the relative voting rights of holders of the common stock. In
the event of a proposed merger, tender offer or other attempt to gain control of
the Company that the Board of Directors did not approve, it might be possible
for the Board of Directors to authorized the issuance of a series of preferred
stock with rights and preferences that would impede the completion of such a
transaction. An effect of the possible issuance of preferred stock, therefore,
may be to deter a future takeover attempt. The Board of Directors has no present
plans or understandings for the issuance of any preferred stock and does not
intend to issue any preferred stock except on terms which the Board of Directors
deems to be in the best interests of the Company and its stockholders. This
preferred stock, none of which has been issued by the Company, together with
authorized but unissued shares of common stock (the Articles of Incorporation
authorizes the issuance of up to 7,000,000 shares of common stock), also could
represent additional capital required to be purchased by the acquiror.

PROCEDURES FOR STOCKHOLDER NOMINATIONS

       The Company's Articles of Incorporation provide that any stockholder
desiring to make a nomination for the election of directors or a proposal for
new business at a meeting of stockholders must submit written notice to the
Secretary of the Company not less than 30 or more than 60 days in advance of the
meeting. The Articles of Incorporation further provides that if a stockholder
seeking to make a nomination or a proposal for new business fails to follow the
prescribed procedures, the chairman of the meeting may disregard the defective
nomination or proposal. Management believes that it is in the best interests of
the Company and its stockholders to provide sufficient time to enable management
to disclose to stockholders information about a dissident slate of nominations
for directors. This advance notice requirement may also give management time to
solicit its own proxies in an attempt to defeat any dissident slate of
nominations should management determine that doing so is in the best interest of
stockholders generally. Similarly, adequate advance notice of stockholder
proposals will give management time to study such proposals and to determine
whether to recommend to the stockholders that such proposals be adopted.

AMENDMENT OF BYLAWS

       The Company's Articles of Incorporation provides that the Company's
Bylaws may be amended either by a two-thirds vote of the Company's Board of
Directors or by the affirmative vote of the holders of not less than 80% of the
outstanding shares of the Company's stock entitled to vote generally in the
election of directors. The Company's Bylaws contain numerous provisions
concerning the Company's governance, such as fixing the number of directors. By

                                       97
reducing the ability of a potential corporate raider to make changes in the
Company's Bylaws and to reduce the authority of the Board of Directors or impede
its ability to manage the Company, this provision could have the effect of
discouraging a tender offer or other takeover attempt where the ability to make
fundamental changes through bylaw amendments is an important element of the
takeover strategy of the acquiror.

AMENDMENT OF ARTICLES OF INCORPORATION

       The Company's Articles of Incorporation provide that specified provisions
contained in the Articles of Incorporation may not be repealed or amended except
upon the affirmative vote of not less than 80% of the outstanding shares of the
Company's stock entitled to vote generally in the election of directors, after
giving effect to any limits on voting rights. This requirement exceeds the two-
thirds vote of the outstanding stock that would otherwise be required by
Virginia law for the repeal or amendment of a provision of the Articles of
Incorporation. The specific provisions are those (i) governing the calling of
special meetings, the absence of cumulative voting rights and the requirement
that stockholder action be taken only at annual or special meetings or by
unanimous written consent, (ii) requiring written notice to the Company of
nominations for the election of directors and new business proposals, (iii)
governing the number of the Company's Directors, the filling of vacancies on the
Board of Directors and classification of the Board of Directors, (iv) providing
the mechanism for removing directors, (v) limiting the acquisition of 10% or
more of the capital stock of the Company (except, with the prior approval of the
Continuing Directors of the Company), (vi) governing the requirement for the
approval of certain Business Combinations involving a "Related Person," (vii)
regarding the consideration of certain nonmonetary factors in the event of an
offer by another party, (viii) providing for the indemnification of directors,
officers, employees and agents of the Company, (ix) pertaining to the
elimination of the liability of the directors to the Company and its
stockholders for monetary damages, with certain exceptions, and (x) governing
the required stockholder vote for amending the Articles of Incorporation or
Bylaws of the Company. This provision is intended to prevent the holders of less
than 80% of the outstanding stock of the Company from circumventing any of the
foregoing provisions by amending the Articles of Incorporation to delete or
modify one of such provisions. This provision would enable the holders of more
than 20% of the Company's voting stock to prevent amendments to the Company's
Articles of Incorporation or Bylaws, even if such amendments were favored by the
holders of a majority of the voting stock.

BENEFIT PLANS

       In addition to the provisions of the Company's Articles of Incorporation
and Bylaws described above, certain benefit plans of the Company and the
Converted Bank adopted in connection with the Conversion contain provisions
which also may discourage hostile takeover attempts which the Boards of
Directors of the Converted Bank might conclude are not in the best interests of
the Company, the Converted Bank or the Company's stockholders. For a description
of the benefit plans and the provisions of such plans relating to changes in
control of the Company or the Converted Bank, see "Management of the Bank --
Proposed Future Stock Benefit Plans."

THE PURPOSE OF AND ANTI-TAKEOVER EFFECT OF THE COMPANY'S ARTICLES OF
INCORPORATION AND BYLAWS

       We believe that the provisions described above reduce the Company's
vulnerability to takeover attempts and certain other transactions which have not
been negotiated with and approved by our Board of Directors. These provisions
will also assist the Company and the Converted Bank in the orderly deployment of
the net proceeds of the Stock Conversion into productive assets during the
initial period after the Stock Conversion. We believe these provisions are in
the best interests of the Converted Bank and of the Company and its
stockholders. In our judgment, the Company's Board of Directors is in the best
position to consider all relevant factors and to negotiate for what is in the
best interests of the stockholders and the Company's other constituents.
Accordingly, we believe that it is in the best interests of the Company and its
stockholders to encourage potential acquirors to negotiate directly with the
Company's Board of Directors, and that these provisions will encourage such
negotiations and discourage nonnegotiated takeover attempts. It is also our view
that these provisions should not discourage persons from proposing a merger or
other transaction at prices reflective of the true value of the Company and
which are in the best interests of all stockholders.

                                       98
Attempts to acquire control of financial institutions and their holding
companies have become increasingly common. Takeover attempts which have not been
negotiated with and approved by the Board of Directors present to stockholders
the risk of a takeover on terms which may be less favorable than might otherwise
be available. A transaction which is negotiated and approved by the Board of
Directors, on the other hand, can be carefully planned and undertaken at an
opportune time in order to obtain maximum value for the Company and
stockholders, with due consideration given to matters such as the management and
business of the acquiring corporation and maximum strategic development of the
Company's assets.

       An unsolicited takeover proposal can seriously disrupt the business and
management of a corporation and cause great expense. Although a tender offer or
other takeover attempt may be made at a price substantially above then current
market prices, such offers are sometimes made for less than all the outstanding
shares of a target company. As a result, stockholders may be presented with the
alternative of partially liquidating their investment at a time that may be
disadvantageous, or retaining their investment in an enterprise which is under
different management and whose objectives may not be similar to those of the
remaining stockholders. The concentration of control that could result from a
tender offer or other takeover attempt could also deprive the Company's
remaining stockholders of certain protective provisions of the Exchange Act.

       Despite our belief as to the benefits to stockholders of these provisions
of the Company's Articles of Incorporation and Bylaws, these provisions may also
have the effect of discouraging a future takeover attempt which would not be
approved by the Company's Board of Directors but pursuant to which the
stockholders may receive a substantial premium for their shares over then
current market prices. As a result, stockholders who might desire to participate
in such a transaction may not have any opportunity to do so. Such provisions
will also render the removal of the Company's Board of Directors and management
more difficult and may tend to stabilize the Company's stock price, thus
limiting gains which might otherwise be reflected in price increases due to a
potential merger or acquisition. The Board of Directors, however, has concluded
that the potential benefits of these provisions outweigh the possible
disadvantages. Pursuant to applicable regulations, at any annual or special
meeting of its stockholders after the Stock Conversion, the Company may adopt
additional Articles of Incorporation provisions regarding the acquisition of its
equity securities that would be permitted to a Virginia corporation. We do not
presently intend to propose the adoption of further restrictions on the
acquisition of the Company's equity securities.

                         DESCRIPTION OF CAPITAL STOCK

GENERAL

       The Company is authorized to issue 7,000,000 shares of common stock, par
value $.01 per share, and 1,000,000 shares of serial preferred stock, $.01 par
value per share. The Company currently expects to sell between 1,275,000 and
1,725,000 shares, subject to adjustment, of the common stock, and issue 150,000
shares of common stock to the Foundation, in the Stock Conversion. The Company
will not issue any shares of serial preferred stock in the Stock Conversion. If
the Option Plan is adopted and implemented, the Company will reserve for future
issuance under the Option Plan an amount of authorized but unissued shares of
common stock equal to 10% of the shares to be issued in the Stock Conversion,
including shares to be contributed to the Foundation. THE CAPITAL STOCK OF THE
COMPANY WILL REPRESENT NONWITHDRAWABLE CAPITAL, WILL NOT BE AN ACCOUNT OF AN
INSURABLE TYPE, AND WILL NOT BE INSURED BY THE FDIC OR ANY OTHER FEDERAL OR
STATE GOVERNMENTAL AGENCY.

COMMON STOCK

       Voting Rights.  Each share of the common stock will have the same
relative rights and will be identical in all respects with every other share of
the common stock. The holders of the common stock will possess exclusive voting

                                       99
rights in the Company, except to the extent that shares of serial preferred
stock issued in the future may have voting rights, if any. Each holder of shares
of the common stock will be entitled to one vote for each share held of record
on all matters submitted to a vote of holders of shares of the common stock.
Stockholders are not permitted to cumulate votes in the election of directors.
For information regarding a possible reduction in voting rights, see "Certain
Anti-Takeover Provisions in the Articles of Incorporation and Bylaws --
Restrictions on Acquisitions of Securities."

       Dividends.  The Company may, from time to time, declare dividends to the
holders of the common stock, who will be entitled to share equally in any such
dividends. For information as to cash dividends, see "Dividend Policy,"
"Regulation -- Depository Institution Regulation -- Dividend Restrictions" and
"Taxation."

       Liquidation.  In the event of any liquidation, dissolution or winding up
of the Converted Bank, the Company, as holder of all of the Converted Bank's
capital stock, would be entitled to receive all assets of the Converted Bank
after payment of all debts and liabilities of the Converted Bank and after
distribution of the balance in the liquidation account to Eligible Account
Holders and Supplemental Eligible Account Holders. In the event of a
liquidation, dissolution or winding up of the Company, each holder of shares of
the common stock would be entitled to receive, after payment of all debts and
liabilities of the Company, a pro rata portion of all assets of the Company
available for distribution to holders of the common stock. If any serial
preferred stock is issued, the holders thereof may have a priority in
liquidation or dissolution over the holders of the common stock. The Bank
Conversion shall not be considered a "liquidation" of the Converted Bank, and
after the Bank Conversion the Converted Bank will continue to maintain the
liquidation account established by the Converted Bank in the Stock Conversion
according to the same terms.

       Restrictions on Acquisition of the Common Stock.  For information
regarding limitations on acquisition of shares of the common stock, see "Certain
Restrictions on Acquisition of the Company and the Converted Bank," "Certain
Anti-Takeover Provisions in the Articles of Incorporation and Bylaws."

       Other Characteristics.  Holders of the common stock will not have
preemptive rights with respect to any additional shares of the common stock
which may be issued. Therefore, the Board of Directors may sell shares of
capital stock of the Company without first offering such shares to existing
shareholders of the Company. The common stock is not subject to call for
redemption, and the outstanding shares of the common stock, when issued and upon
receipt by the Company of the full purchase price therefor, will be fully paid
and nonassessable.

       Transfer Agent and Registrar.  The transfer agent and registrar for the
common stock will be____________,  _______, ____________.

SERIAL PREFERRED STOCK

       None of the 1,000,000 authorized shares of serial preferred stock of the
Company will be issued in the Stock Conversion. After the Stock Conversion is
completed, the Board of Directors of the Company will be authorized to issue
serial preferred stock and to fix and state voting powers, designations,
preferences or other special rights of such shares and the qualifications,
limitations and restrictions thereof. The serial preferred stock may rank prior
to the common stock as to dividend rights or liquidation preferences, or both,
and may have full or limited voting rights. The Board of Directors has no
present intention to issue any of the serial preferred stock. Should the Board
of Directors of the Company subsequently issue serial preferred stock, no holder
of any such stock shall have any preemptive right to subscribe for or purchase
any stock or any other securities of the Company other than such, if any, as the
Board of Directors, in its sole discretion, may determine and at such price or
prices and upon such other terms as the Board of Directors, in its sole
discretion, may fix.

                                      100
REGISTRATION REQUIREMENTS

       The Company will register its common stock with the SEC pursuant to the
Exchange Act upon the completion of the Stock Conversion and will not deregister
said shares for a period of at least three years following the completion of the
Stock Conversion. Upon such registration, the proxy and tender offer rules,
insider trading reporting and restrictions, annual and periodic reporting and
other requirements of the Exchange Act will be applicable. The Company intends
to have a fiscal year end of September 30.

                                 LEGAL MATTERS

       The legality of the common stock will be passed upon for the Company by
Housley Kantarian & Bronstein, P.C., Washington, D.C. Housley Kantarian &
Bronstein, P.C. has consented to the references herein to its opinion. Certain
legal matters will be passed upon for Trident Securities by Patton Boggs LLP,
Washington, D.C.

                                 TAX OPINIONS

       The federal income tax consequences of the Stock Conversion will be
passed upon by Housley Kantarian & Bronstein, P.C., Washington, D.C. Housley
Kantarian & Bronstein, P.C. has consented to the references herein to its
opinion. The North Carolina income tax consequences of the Stock Conversion will
be passed upon by KPMG Peat Marwick LLP, which has consented to the references
herein to its opinion.

                                    EXPERTS

       The consolidated financial statements of 1st State Bank and subsidiary as
of September 30, 1998 and 1997, and for each of the years in the three-year
period ended September 30, 1998, have been included herein and in the
registration statement in reliance upon the report of KPMG Peat Marwick LLP,
independent certified public accountants, appearing elsewhere herein, and upon
the authority of said firm as experts in accounting and auditing.

       Ferguson has consented to the publication herein of the summary of its
letter to us setting forth its opinion as to the estimated pro forma aggregate
market value of the common stock to be issued in the Stock Conversion and the
value of subscription rights to purchase the common stock and to the use of its
name and statements with respect to it appearing in this document.

                            ADDITIONAL INFORMATION

       The Company has filed with the SEC a Registration Statement on Form S-1
under the Securities Act with respect to the common stock offered in this
document. As permitted by the rules and regulations of the SEC, this document
does not contain all the information set forth in the registration statement.
Such information can be examined without charge at the public reference
facilities of the SEC located at 450 Fifth Street, N.W., Washington, D.C. 20549,
and copies of such material can be obtained from the SEC at prescribed rates.
You may obtain information on the operation of the SEC's public reference room
by calling the SEC at 1-800-SEC-0330. The SEC also maintains an internet address
("web site") that contains reports, proxy and information statements and other
information regarding registrants, including the Company, that file
electronically with the SEC. The address for this web site is " http: //www.
sec. gov." The statements contained in this document as to the contents of any
contract or other document filed as an exhibit to the Form S-1 describe the
material features of such contract or document are, of necessity, brief
descriptions and are not necessarily complete; each such statement is qualified
by reference to such contract or document.

                                      101
We have filed an Application to Convert a Mutual Savings Bank to a Stock
Owned Savings Bank with the Administrator. Pursuant to the North Carolina
conversion regulations, this Prospectus omits certain information contained in
that Application. The Application, which contains a copy of Ferguson's
appraisal, may be inspected at the office of the Administrator, Savings
Institutions Division, North Carolina Department of Commerce, Tower Building,
Suite 301, 1110 Navaho Drive, Raleigh, North Carolina 27609. Copies of the Plan
of Conversion, which includes a copy of the Converted Bank's proposed Amended
and Restated Articles of Incorporation and Bylaws, are available for inspection
at each office of the Bank and may be obtained by writing to the Bank at 445 S.
Main Street, Burlington, North Carolina 27815; Attention James C. McGill,
President or by telephoning the Bank at (336) 227-8861. A copy of Ferguson's
independent appraisal is also available for inspection at the Stock Information
Center.

                                      102
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Page
                                                                      ----
Independent Auditors' Report                                          F-1
                                                                        
Consolidated Balance Sheets as of  September 30, 1998 and 1997        F-2
                                                                        
Consolidated Statements of Income for the Years Ended                 F-3
  September 30, 1998, 1997 and 1996                                     
                                                                        
Consolidated Statements of Net Worth for the Years Ended              F-4
  September 30, 1998, 1997 and 1996                                     
                                                                        
Consolidated Statements of Cash Flows for the Years Ended             F-5
  September 30, 1998, 1997 and 1996                                     
                                                                        
Notes to Consolidated Financial Statements                            F-7
Schedules - All schedules are omitted because the required information is not
applicable or is presented in the financial statements or accompanying notes.

       All financial statements of 1st State Bancorp, Inc. have been omitted
because 1st State Bancorp, Inc. has not yet issued any stock, has no assets and
no liabilities and has not conducted any business other than of an
organizational nature.

                                      103
INDEPENDENT AUDITORS' REPORT

The Board of Directors
1st State Bank
Burlington, North Carolina

We have audited the accompanying consolidated balance sheets of 1st State Bank
and subsidiary as of September 30, 1998 and 1997 and the related consolidated
statements of income, net worth and cash flows for each of the years in the
three-year period ended September 30, 1998. These consolidated financial
statements are the responsibility of the Bank's management. Our responsibility
is to express an opinion on these consolidated financial statements based on our
audits.

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

In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of 1st State Bank and
subsidiary at September 30, 1998 and 1997, and the results of their operations
and their cash flows for each of the years in the three-year period ended
September 30, 1998, in conformity with generally accepted accounting principles.
 

                                    /s/ KPMG Peat Marwick LLP 
                                    KPMG Peat Marwick LLP

Greensboro, North Carolina
October 30, 1998

                                      F-1
1ST STATE BANK AND SUBSIDIARY

                          Consolidated Balance Sheets

                          September 30, 1998 and 1997
ASSETS                                            1998                1997
                                                                               ----------------   -----------------
Cash and cash equivalents                                                     $     31,077,054          14,990,413
Investment securities (note 2):
    Held to maturity (fair value of $30,415,447 and $23,539,770
       at September 30, 1998 and 1997, respectively)                                30,195,094          23,481,510
    Available for sale (cost of $9,705,529 and $11,441,164 at
       September 30, 1998 and 1997, respectively)                                    9,857,780          11,319,777
Loans held for sale, at lower of cost or fair value                                  7,539,919             684,438
Loans receivable (net of allowance for loan losses of $3,227,775
    and $2,753,793 at September 30 1998 and 1997, respectively)
    (notes 3, 4 and 8)                                                             196,782,275         197,121,798
Federal Home Loan Bank stock, at cost (notes 5 and 8)                                1,346,500           1,281,200
Premises and equipment (note 6)                                                      7,513,347           6,771,800
Accrued interest receivable                                                          1,807,588           1,556,828
Other assets (note 10)                                                               2,103,659           1,301,640
                                                                               ----------------   -----------------
                  Total assets                                                $    288,223,216         258,509,404
                                                                               ================   =================

                         LIABILITIES AND NET WORTH

Liabilities:
    Deposit accounts (note 7)                                                 $    235,693,715         229,340,603
    Advances from Federal Home Loan Bank (note 8)                                   20,000,000           1,000,000
    Advance payments by borrowers for property taxes and
       insurance                                                                       299,939             387,799
    Other liabilities (notes 10 and 11)                                              6,263,957           4,503,659
                                                                               ----------------   -----------------
                  Total liabilities                                                262,257,611         235,232,061
                                                                               ----------------   -----------------
Commitments (notes 3 and 12) 

Net worth (note 9):
    Retained income - substantially restricted                                      25,872,605          23,351,343
    Net unrealized gain (loss) on investment securities
       available for sale (note 2)                                                      93,000             (74,000)
                                                                               ----------------   -----------------
                  Total net worth                                                   25,965,605          23,277,343
                                                                               ----------------   -----------------
                  Total liabilities and net worth                             $    288,223,216         258,509,404
                                                                               ================   =================
See accompanying notes to consolidated financial statements.

                                      F-2
1ST STATE BANK AND SUBSIDIARY

                       Consolidated Statements of Income

             For the Years Ended September 30, 1998, 1997 and 1996
1998                1997                1996
                                                             ----------------    ----------------    ----------------
Interest income:                                                                                                      
    Interest and fees on loans                               $     17,184,941          16,167,269          14,620,562 
    Interest and dividends on investments                           2,319,980           2,557,133           2,401,615 
    Overnight deposits                                              1,203,594             336,426             372,900 
                                                             ----------------    ----------------    ---------------- 
                  Total interest income                            20,708,515          19,060,828          17,395,077 
                                                             ----------------    ----------------    ---------------- 
Interest expense:                                                                                                     
    Deposit accounts (note 7)                                      10,330,999           9,743,038           9,450,414 
    Borrowings (note 8)                                               740,439              55,910               3,152 
                                                             ----------------    ----------------    ---------------- 
                  Total interest expense                           11,071,438           9,798,948           9,453,566 
                                                             ----------------    ----------------    ---------------- 
                  Net interest income                               9,637,077           9,261,880           7,941,511
                                                             
Provision for loan losses (note 4)                                   (477,017)           (261,288)           (280,550)
                                                             ----------------    ----------------    ---------------- 
                  Net interest income after provision                                                                 
                     for loan losses                                9,160,060           9,000,592           7,660,961 
                                                             ----------------    ----------------    ---------------- 
Other income:                                                                                                         
    Loan servicing fees (note 3)                                      103,280             108,517             125,440 
    Customer service fees                                             565,693             500,216             411,936 
    Commission from sales of annuities and                                                                            
        mutual funds                                                  436,568             399,058             285,891 
    Real estate operations, net                                        (1,734)             19,808              32,216 
    Mortgage banking income, net                                      436,401             180,809             103,454 
    Securities losses, net (note 2)                                  (246,259)                 --                  -- 
    Other                                                             203,581             259,343             220,039 
                                                             ----------------    ----------------    ---------------- 
                  Total other income                                1,497,530           1,467,751           1,178,976 
                                                             ----------------    ----------------    ---------------- 
Operating expenses:                                                                                                   
    Compensation and related benefits (note 11)                     4,612,183           4,344,800           2,949,424 
    Occupancy and equipment (note 12)                               1,044,147             939,544             845,799 
    Deposit insurance premiums                                        142,015             103,707             464,644 
    Other expenses                                                    975,983           1,084,618             860,034 
    SAIF assessment (note 7)                                               --                  --           1,283,320 
                                                             ----------------    ----------------    ---------------- 
                  Total operating expenses                          6,774,328           6,472,669           6,403,221 
                                                             ----------------    ----------------    ---------------- 
                  Income before income taxes                        3,883,262           3,995,674           2,436,716 
                                                                                                                      
Income taxes (note 10)                                              1,362,000           1,447,100             840,500 
                                                             ----------------    ----------------    ---------------- 
                  Net income                                 $      2,521,262           2,548,574           1,596,216 
                                                             ================    ================    ================
See accompanying notes to consolidated financial statements.

                                      F-3
1ST STATE BANK AND SUBSIDIARY

                     Consolidated Statements of Net Worth

             For the Years Ended September 30, 1998, 1997 and 1996
Net
                                                                                      Unrealized
                                                                                     Gain (Loss) on
                                                                                      Investment
                                                                                      Securities             Total
                                                                  Retained            Available               Net
                                                                   Income              for Sale              Worth
                                                           --------------------   -------------------   -----------------
Balance at September 30, 1995                              $        19,206,553               (56,000)         19,150,553
Net income                                                           1,596,216                    --           1,596,216
Change in unrealized gain (loss) on investment                                                                        --
    securities available for sale, net of taxes                             --              (118,000)           (118,000)
                                                              -----------------   -------------------   -----------------
Balance at September 30, 1996                                       20,802,769              (174,000)         20,628,769
Net income                                                           2,548,574                    --           2,548,574
Change in unrealized gain (loss) on investment                                                                        --
    securities available for sale, net of taxes                             --               100,000             100,000
                                                              -----------------   -------------------   -----------------
Balance at September 30, 1997                                       23,351,343               (74,000)         23,277,343
Net income                                                           2,521,262                    --           2,521,262
Change in unrealized gain (loss) on investment                                                                        --
    securities available for sale, net of taxes                             --               167,000             167,000
                                                              -----------------   -------------------   -----------------
Balance at September 30, 1998                              $        25,872,605                93,000          25,965,605
                                                              =================   ===================   =================
See accompanying notes to consolidated financial statements.

                                      F-4
1ST STATE BANK AND SUBSIDIARY

                     Consolidated Statements of Cash Flows

                 Years ended September 30, 1998, 1997 and 1996
1998                1997               1996
                                                             ------------------   -----------------  -----------------
Cash flows from operating activities:
    Net income                                               $        2,521,262           2,548,574          1,596,216
    Adjustments to reconcile net income to net cash
       provided (used) by operating activities:
         Provision for loan losses                                      477,017             261,288            280,550
         Depreciation                                                   424,997             270,572            239,130
         Deferred income tax expense (benefit)                         (601,000)            139,000            172,000
         Amortization of premiums and discounts, net                     24,419             (37,116)            (2,112)
         Loan origination fees and unearned discounts
            deferred, net of current amortization                         2,221             104,658            115,328
         Net loss on sale of loans                                      118,633              15,520            122,309
         Gain on sale of other real estate                                   --             (21,288)           (43,319)
         Securities losses, net                                         246,259                  --                 --
         Proceeds from loans held for sale                           27,635,212           9,165,706          9,181,331
         Originations of loans held for sale                        (34,609,326)         (9,765,263)       (11,695,278)
         Decrease (increase) in other assets                           (307,657)            586,726           (227,523)
         Increase in accrued interest receivable                       (250,760)           (133,747)          (101,534)
         Increase in other liabilities                                1,760,298           1,042,830            606,880
                                                                ---------------    ----------------   ----------------
                   Net cash provided by (used in)
                      operating activities                           (2,558,425)          4,177,460            243,978
                                                                ---------------    ----------------   ----------------
Cash flows from investing activities:
    Purchase of FHLB stock                                              (65,300)            (35,500)           (11,900)
    Purchases of investment securities held to
       maturity                                                     (32,614,244)         (6,998,750)       (12,379,167)
    Purchases of investment securities available for
       sale                                                          (2,002,500)                 --         (3,972,438)
    Proceeds from sales of investment securities                                                  
       available for sale                                             2,879,973                  --                 --
    Proceeds from maturities of investment
       securities available for sale                                    588,144           4,000,000          3,000,000
    Proceeds from maturities of investment
       securities held to maturity                                   25,900,000           6,107,200          9,407,696
    Net increase in loans receivable                                   (139,715)        (21,361,303)        (3,211,526)
    Capital expenditures on real estate acquired in
       settlement of loans                                                   --                  --             (6,692)
    Proceeds from disposal of real estate acquired in                         
       settlement of loans                                                   --              22,289            123,478
    Purchases of premises and equipment                              (1,166,544)           (355,006)        (1,127,174)
                                                                ---------------    ----------------   ----------------
                   Net cash used in investing activities             (6,620,186)        (18,621,070)        (8,177,723)
                                                                ---------------    ----------------   ----------------
(Continued)

                                      F-5
1ST STATE BANK AND SUBSIDIARY

                Consolidated Statements of Cash Flows - Continued

                  Years ended September 30, 1998, 1997 and 1996
1998                1997               1996
                                                               -----------------   -----------------  -----------------
Cash flows from financing activities:
    Net increase in deposits                                   $      6,353,112          19,633,862          8,937,737
    Increase (decrease) in advance payments by
       borrowers for property taxes and insurance                       (87,860)             45,819            199,939
    Advances from Federal Home Loan Bank                             20,000,000              --              1,000,000
    Repayments of advances from Federal Home
       Loan Bank                                                     (1,000,000)             --                 --
                                                                ----------------   -----------------  -----------------
                   Net cash provided by financing
                      activities                                     25,265,252          19,679,681         10,137,676
                                                                ----------------   -----------------  -----------------
                   Net increase in cash and cash
                      equivalents                                    16,086,641           5,236,071          2,203,931
Cash and cash equivalents at beginning of year                       14,990,413           9,754,342          7,550,411
                                                                ----------------   -----------------  -----------------
                   Cash and cash equivalents at end
                      of year                                  $     31,077,054          14,990,413          9,754,342
                                                                ================   =================  =================
Payments are shown below for the following:
    Interest                                                   $     10,947,338           9,777,417          9,455,792
                                                                ================   =================  =================
    Income taxes                                               $      2,301,000             866,300          1,657,500
                                                                ================   =================  =================
Noncash investing and financing activities:
    Transfer from loans to real estate acquired in
       settlement of loans                                     $         --                  --                 73,468
                                                                ================   =================  =================
    Transfer from loans held for sale to loans
       receivable                                              $         --               2,277,071             --
                                                                ================   =================  =================
See accompanying notes to consolidated financial statements.

                                      F-6
1ST STATE BANK AND SUBSIDIARY

                  Notes to Consolidated Financial Statements

                       September 30, 1998, 1997 and 1996

                  (With Independent Auditors' Report Thereon)

(1)  SIGNIFICANT ACCOUNTING POLICIES

     (A)  BASIS OF PRESENTATION

          The consolidated financial statements include the accounts of 1st
          State Bank, SSB and its wholly-owned subsidiary, First Capital
          Services Company, LLC (collectively referred to as "the Bank"). First
          Capital Services Company, LLC is engaged primarily in the sale of
          insurance products. Intercompany balances and transactions have been
          eliminated.

     (B)  USE OF ESTIMATES

          The preparation of the consolidated financial statements in conformity
          with generally accepted accounting principles requires management to
          make estimates and assumptions that affect reported amounts of assets
          and liabilities at the date of the financial statements and the
          amounts of income and expenses during the reporting period. Actual
          results could differ from those estimates.

     (C)  CASH AND CASH EQUIVALENTS

          For purposes of reporting cash flows, cash and cash equivalents
          include cash and interest-bearing overnight deposits with the Federal
          Home Loan Bank ("FHLB") of Atlanta. At September 30, 1998 and 1997,
          interest-bearing overnight deposits were $25,558,925 and $7,813,209,
          respectively.

     (D)  INVESTMENT SECURITIES

          Investment securities that the Bank has the positive intent and
          ability to hold to maturity are classified as held to maturity and
          reported at amortized cost. Investment securities held for current
          resale are classified as trading securities and reported at fair
          value, with unrealized gains and losses included in earnings.
          Investment securities not classified either as securities held to
          maturity or trading securities are classified as available for sale
          and reported at fair value, with net unrealized gains and losses net
          of related taxes excluded from earnings and reported as a separate
          component of net worth. The classification of investment securities as
          held to maturity, trading or available for sale is determined at the
          date of purchase.

          Realized gains and losses from sales of investment securities are
          determined based upon the specific identification method. Premiums and
          discounts are amortized as an adjustment to yield over the remaining
          lives of the securities using the level-yield method.

                                                                     (Continued)

                                      F-7
1ST STATE BANK AND SUBSIDIARY

                  Notes to Consolidated Financial Statements

                       September 30, 1998, 1997 and 1996

                  (With Independent Auditors' Report Thereon)

          Management periodically evaluates investment securities for other than
          temporary declines in value and records any losses through an
          adjustment to earnings.

     (E)  LOANS HELD FOR SALE

          Loans held for sale are carried at the lower of cost or fair value in
          the aggregate as determined by outstanding commitments from investors
          or current investor yield requirements. Gains and losses on loan sales
          are determined by the difference between the selling price and the
          carrying value of the loans sold.

     (F)  LOANS RECEIVABLE

          Interest on loans, including impaired loans, that are contractually
          ninety days or more past due is generally either charged off or
          reserved through an allowance account. The allowance is established by
          a charge to interest income equal to all interest previously accrued.
          In certain circumstances, interest on loans that are contractually
          ninety days or more past due is not charged off or reserved through an
          allowance account when management determines that the loan is both
          well secured and in the process of collection. If amounts are received
          on loans for which the accrual of interest has been discontinued, a
          determination is made as to whether payments received should be
          recorded as a reduction of the principal balance or as interest income
          depending on management's judgment as to the collectibility of
          principal. The loan is returned to accrual status when, in
          management's judgment, the borrower has demonstrated the ability to
          make periodic interest and principal payments on a timely basis.

     (G)  LOAN ORIGINATION FEES AND RELATED COSTS

          Loan origination fees and certain direct loan origination costs are
          deferred, and the net fee or cost is recognized as an adjustment of
          the loan yield using the level-yield method over the contractual life
          of the related loans.

     (H)  ALLOWANCE FOR LOAN LOSSES

          The allowance for loan losses is established through provisions for
          loan losses charged against income. Loans deemed to be uncollectible
          are charged against the allowance for loan losses, and subsequent
          recoveries, if any, are credited to the allowance.

          Management's evaluation of the adequacy of the allowance is based on a
          review of individual loans, historical loan loss experience, the value
          and adequacy of collateral, and economic conditions in the Bank's
          market area. This evaluation is inherently subjective as it requires
          material estimates, including the amounts and timing of future cash
          flows expected to be

                                      F-8                           (Continued)
1ST STATE BANK AND SUBSIDIARY

                  Notes to Consolidated Financial Statements

                       September 30, 1998, 1997 and 1996

                  (With Independent Auditors' Report Thereon)

          received on impaired loans that may be susceptible to significant
          change. Various regulatory agencies, as an integral part of their
          examination process, periodically review the Bank's allowance for loan
          losses. Such agencies may require the Bank to recognize changes to the
          allowance based on their judgments about information available to them
          at the time of their examinations.

          For all specifically reviewed loans for which it is probable that the
          Bank will be unable to collect all amounts due according to the terms
          of the loan agreement, the Bank determines impairment by computing a
          fair value either based on discounted cash flows using the loans'
          initial interest rate or the fair value of the collateral if the loan
          is collateral dependent. Large groups of smaller balance homogenous
          loans that are collectively evaluated for impairment (such as
          residential mortgage and consumer installment loans) are excluded from
          impairment evaluation, and their allowance for loan losses is
          calculated in accordance with the allowance for loan losses policy
          described above.

     (I)  REAL ESTATE ACQUIRED IN SETTLEMENT OF LOANS

          Real estate acquired in settlement of loans by foreclosure or deed in
          lieu of foreclosure is initially recorded at the lower of cost (unpaid
          loan balance plus costs of obtaining title and possession) or fair
          value less estimated costs to sell at the time of acquisition.
          Subsequent costs directly related to development and improvement of
          property are capitalized, whereas costs relating to holding property
          are expensed.

          When the carrying value of real estate exceeds its fair value, less
          cost to sell, an allowance for loss on real estate is established and
          a provision for loss on real estate is charged to other expenses. At
          September 30, 1998 and 1997, the Bank had no real estate acquired in
          settlement of loans.

     (J)  PREMISES AND EQUIPMENT

          Premises and equipment are carried at cost less accumulated
          depreciation. Depreciation is computed generally by the straight-line
          method over the estimated useful lives of the related assets.
          Estimated lives are 15 to 50 years for buildings and 3 to 15 years for
          furniture, fixtures and equipment.

     (K)  INCOME TAXES

          Deferred income taxes are recognized for the future tax consequences
          attributed to differences between the financial statement carrying
          amounts of existing assets and liabilities and their respective tax
          bases. Deferred tax assets and liabilities are measured using enacted
          tax rates in

                                      F-9                            (Continued)
1ST STATE BANK AND SUBSIDIARY

                  Notes to Consolidated Financial Statements

                       September 30, 1998, 1997 and 1996

                  (With Independent Auditors' Report Thereon)

          effect for the year in which the temporary differences are expected to
          be recovered or settled. Deferred tax assets are reduced by a
          valuation allowance if it is more likely than not that the tax
          benefits will not be realized. The effect on deferred tax assets and
          liabilities of a change in tax rates is recognized in income in the
          period that includes the enactment date.

     (L)  RECLASSIFICATIONS

          Certain amounts in the 1997 and 1996 consolidated financial statements
          have been reclassified to conform with the presentation adopted in
          1998. Such reclassifications did not change net income or net worth as
          previously reported.

(2)  INVESTMENT SECURITIES

     Investment securities consist of the following:
AMORTIZED           UNREALIZED          UNREALIZED             FAIR
                                                         COST               GAINS               LOSSES               VALUE      
                                                   ---------------    ----------------    ----------------     ----------------
SEPTEMBER 30, 1998                                                                                              
     Held to maturity:                                                                                                          
          U.S. Government and agency                                                                                            
              securities                          $     30,087,456             219,742                  --           30,307,198 
          Collateralized mortgage                                                                                               
              obligations                                  107,638                 611                  --              108,249 
                                                   ---------------    ----------------    ----------------     ----------------  
                          Total                   $     30,195,094             220,353                  --           30,415,447 
                                                   ===============    ================    ================     ================ 
     Available for sale:                                                                                                        
          U.S. Government and                                                                                                   
              agency securities                          4,001,142              42,363                (232)           4,043,273 
          Marketable equity securities                   3,993,081              13,120                  --            4,006,201 
          FHLMC mortgage-backed                                                                                                 
              securities                                   648,029              13,550                  --              661,579 
          GNMA mortgage-backed                     
              securities                                 1,063,277              83,450                  --            1,146,727 
                                                   ---------------    ----------------    ----------------     ----------------  
                          Total                   $      9,705,529             152,483                (232)           9,857,780 
                                                   ===============    ================    ================     ================
F-10                            (Continued)
1ST STATE BANK AND SUBSIDIARY

                  Notes to Consolidated Financial Statements

                       September 30, 1998, 1997 and 1996

                  (With Independent Auditors' Report Thereon)
AMORTIZED           UNREALIZED          UNREALIZED              FAIR
                                              COST               GAINS               LOSSES               VALUE
                                        ----------------    ----------------    ----------------     ----------------
SEPTEMBER 30, 1997                                                                                                   
Held to maturity:                                                                                                          
   U.S. Government and agency                                                                                           
    securities                           $    23,337,997              82,229             (26,750)          23,393,476 
   Collateralized mortgage                                                                                                    
    obligations                                  143,513               2,781                  --              146,294 
                                         ---------------    ----------------    ----------------     ----------------  
                    Total                $    23,481,510              85,010             (26,750)          23,539,770 
                                         ===============    ================    ================     ================ 
Available for sale:                                                                                                        
   U.S. Government and                                                                                                   
    agency securities                          3,993,052              18,949                  --            4,012,001 
   Marketable equity securities                4,262,331                  --            (301,949)           3,960,382 
   FHLMC mortgage-backed                                                                                                      
    securities                                 1,507,153              60,679              (3,499)           1,564,333 
   GNMA mortgage-backed                                                                                                       
    securities                                 1,650,088             104,251                  --            1,754,339 
   FNMA mortgage-backed                                                                                                       
    securities                                    28,540                 182                  --               28,722 
                                         ---------------    ----------------    ----------------     ----------------  
               Total                     $    11,441,164             184,061            (305,448)          11,319,777   
                                         ===============    ================    ================     ================
Following is a summary of investments in debt securities by maturity at
September 30, 1998.  Marketable equity securities, mortgage-backed securities
and collateralized mortgage obligations do not have single maturity dates and
are not included below.
AMORTIZED              FAIR      
                                                                           COST               VALUE      
                                                                    ----------------    ----------------
Held to maturity:                                                                                        
  Within one year                                                   $      3,992,563           4,014,606 
  After one but within five years                                         15,471,247          15,599,483 
  After five but within ten years                                          9,623,646           9,687,469 
  After ten years                                                          1,000,000           1,005,640 
                                                                    ----------------    ----------------  
               Total                                                $     30,087,456          30,307,198 
                                                                    ================    ================ 
Available for sale:                                                                                      
  After one but within five years                                   $      3,001,142           3,043,505 
  After five but within ten years                                          1,000,000             999,768 
                                                                    ----------------    ----------------  
               Total                                                $      4,001,142           4,043,273 
                                                                    ================    ================
F-11                           (Continued)
1ST STATE BANK AND SUBSIDIARY

                  Notes to Consolidated Financial Statements

                       September 30, 1998, 1997 and 1996

                  (With Independent Auditors' Report Thereon)

     During the year ended September 30, 1998, the Bank recognized gross gains
     on the sale of investment securities available for sale of approximately
     $23,000. There were no sales in 1997 and 1996. The Bank also recognized a
     loss of approximately $269,000 on the write-down of marketable equity
     securities for an other than temporary decline in value during the year
     ended September 30, 1998.

     At September 30, 1998, U.S. Government securities with an amortized cost of
     approximately $2,000,000 were pledged as collateral for certain deposit
     accounts.

(3)  LOANS RECEIVABLE

     Loans receivable are summarized as follows:
SEPTEMBER 30,            
                                                                                  1998                 1997      
                                                                           ----------------     ----------------
Real estate loans:                                                                                          
          One-to-four family residential                                   $    100,891,490          108,399,580 
          Commercial real estate and other properties                            38,763,299           34,333,514 
          Home equity and property improvement                                   16,877,066           18,140,649 
          Construction loans                                                     18,571,550           12,582,348 
                                                                           ----------------     ---------------- 
                         Total real estate loans                                175,103,405          173,456,091 
                                                                           ----------------     ---------------- 
     Other loans:                                                                                                
          Commercial                                                             25,189,613           22,869,834 
          Consumer                                                                6,309,951            5,354,150 
                                                                           ----------------     ---------------- 
                         Total other loans                                       31,499,564           28,223,984 
                                                                           ----------------     ---------------- 
     Less:                                                                                                       
          Loans in process                                                       (6,446,324)          (1,660,110)
          Net deferred loan origination fees                                       (146,595)            (144,374)
                                                                           ----------------     ---------------- 
          Net loans receivable before allowance for loan losses                 200,010,050          199,875,591 
          Allowance for loan losses                                              (3,227,775)          (2,753,793)
                                                                           ----------------     ---------------- 
                         Loans receivable, net                             $    196,782,275          197,121,798 
                                                                           ================     ================
At September 30, 1998 and 1997 and during the years then ended there are no
     loans considered to be impaired.

                                       F-12                         (Continued)
1ST STATE BANK AND SUBSIDIARY

                  Notes to Consolidated Financial Statements

                       September 30, 1998, 1997 and 1996

                  (With Independent Auditors' Report Thereon)

     The Bank grants residential, residential construction, commercial real
     estate, home equity and other loans to customers primarily throughout its
     market area of Alamance County which includes the cities of Burlington,
     Mebane and Graham. As reflected in the summary of loans receivable at
     September 30, 1998, the largest component of the Bank's loan portfolio
     consists of lower-risk, one-to-four family residential loans. The higher
     risk components of the loan portfolio consist of real estate construction
     loans, commercial real estate loans and commercial loans for which
     repayment is dependent on the current real estate market and general
     economic conditions. The consumer portfolio generally consists of smaller
     loans to individuals in the Bank's primary market area and can also be
     affected by general economic conditions.

     The Bank's nonaccrual loans amount to approximately $263,000, $259,000 and
     $288,000 at September 30, 1998, 1997 and 1996, respectively. If the Bank's
     nonaccrual loans had been current in accordance with their original terms,
     gross interest income of approximately $10,100, $27,300 and $25,800 would
     have been recorded for the years ended September 30, 1998, 1997 and 1996,
     respectively. Interest income on these loans included in net income was
     approximately $15,000, $15,700 and $12,300 for 1998, 1997 and 1996,
     respectively.

     Loans serviced for others at September 30, 1998 and 1997 were approximately
     $37,000,000 and $43,000,000, respectively. Mortgage servicing rights were
     not material for any of the periods presented.

     The Bank offers mortgage and consumer loans to its officers, directors, and
     employees for the financing of their personal residences and for other
     personal purposes. The Bank also offers commercial loans to companies
     affiliated with directors. These loans are made in the ordinary course of
     business and, in management's opinion, are made on substantially the same
     terms, including interest rates and collateral, prevailing at the time for
     comparable transactions with other persons and companies. Management does
     not believe these loans involve more than the normal risk of collectibility
     or present other unfavorable features, except for certain loans totaling
     approximately $3.5 million to a company affiliated with a director. At
     September 30, 1998, such loans were current with respect to their payment
     terms and except for the waiver of certain debt covenants by the Bank, were
     performing in accordance with the related loan agreements. Based on an
     analysis of the affiliated company's current financial statements,
     management has concerns that the borrower may have difficulty in complying
     with the present loan repayment terms on an ongoing basis.

                                    F-13                            (Continued)
1ST STATE BANK AND SUBSIDIARY

                  Notes to Consolidated Financial Statements

                       September 30, 1998, 1997 and 1996

                  (With Independent Auditors' Report Thereon)

The following is a summary of the activity of loans outstanding to certain
executive officers, directors and their affiliates for the year ended September
30, 1998:
Balance at September 30, 1997                           $       7,495,243
New loans                                                       1,412,420
Repayments                                                      1,387,958
                                                        -----------------
Balance at September 30, 1998                           $       7,519,705
                                                        =================
The Bank is a party to financial instruments with off-balance sheet risk
including commitments to extend credit under existing lines of credit and
commitments to sell loans. These instruments involve, to varying degrees,
elements of credit and interest rate risk in excess of the amount recognized in
the consolidated balance sheets.

Off-balance sheet financial instruments whose contract amount represents credit
and interest rate risk are summarized as follows:
SEPTEMBER 30,
                                                                              1998                   1997
                                                                      -------------------    -------------------
Commitments to originate new loans                                     $        6,650,700              3,860,732
Commitments to originate new loans held for sale                                  833,411                224,863
Unfunded commitments to extend credit under existing equity
  line and commercial lines of credit                                          40,444,057             34,593,971
Commercial letters of credit                                                      505,000                874,709
Commitments to sell loans held for sale                                         1,863,591                684,438
Commitments to originate new loans or to extend credit are agreements to lend to
a customer as long as there is no violation of any condition established in the
contract. Commitments generally have fixed expiration dates or other termination
clauses and may require payment of a fee. Since many of the commitments are
expected to expire without being drawn upon, the total commitment amounts do not
necessarily represent future cash requirements. The Bank evaluates each
customer's creditworthiness on a case-by-case basis. The amount of collateral
obtained, if deemed necessary by the Bank upon extension of credit, is based on
management's credit evaluation of the borrower. The Bank's commitments to extend
credit under existing lines of credit relate principally to home equity lines of
credit which are secured by the borrower's primary residence.

Commitments to sell loans held for sale are agreements to sell loans to a third
party at an agreed upon price. At September 30, 1998, the aggregate fair value
of the commitments exceeded the cost of the loans to be sold.

                                   F-14                            (Continued)
1ST STATE BANK AND SUBSIDIARY

                  Notes to Consolidated Financial Statements

                       September 30, 1998, 1997 and 1996

                  (With Independent Auditors' Report Thereon)

 
(4)  ALLOWANCE FOR LOAN LOSSES

     The following is a summary of the activity in the allowance for loan
     losses:
YEARS ENDED SEPTEMBER 30,
                                                           1998                 1997                 1996
                                                    ----------------     ----------------     ----------------
Balance at beginning of year                    $     2,753,793            2,495,677            2,222,765      
     Provision for loan losses                               477,017              261,288              280,550      
                                                                                                                    
     Charge-offs                                              (3,731)              (7,548)             (12,477)     
     Recoveries                                                  696                4,376                4,839      
                                                    ----------------     ----------------     ----------------   
             Net charge-offs                                  (3,035)              (3,172)              (7,638)
                                                    ----------------     ----------------     ----------------   
             Balance at end of year                  $     3,227,775            2,753,793            2,495,677
                                                    ================     ================     ================
(5)  INVESTMENT IN FHLB STOCK

     As a member of the FHLB of Atlanta, the Bank is required to maintain an
     investment in the stock of the FHLB. This stock is carried at cost since it
     has no quoted fair value. See also note 8.

(6)  PREMISES AND EQUIPMENT

     Premises and equipment consist of the following:
SEPTEMBER 30,
                                                                           1998                 1997
                                                                    ----------------     ----------------
Land                                                           $     2,231,450            2,231,450
     Building and improvements                                            5,166,911            5,166,911
     Furniture and equipment                                              3,987,664            2,821,845
                                                                   ----------------     ---------------- 
                                                                         11,386,025           10,220,206
     Less accumulated depreciation                                       (3,872,678)          (3,448,406)
                                                                   ----------------     ---------------- 
                 Total                                              $     7,513,347            6,771,800
                                                                   ================     ================
F-15                            (Continued)
1ST STATE BANK AND SUBSIDIARY

                  Notes to Consolidated Financial Statements

                       September 30, 1998, 1997 and 1996

                  (With Independent Auditors' Report Thereon)

(7)  DEPOSIT ACCOUNTS

     A comparative summary of deposit accounts follows:
SEPTEMBER 30, 1998
                                                        ------------------------------------- 
                                                                                 WEIGHTED    
                                                             BALANCE           AVERAGE RATE  
                                                        ----------------    -----------------
Transactions accounts:                                                        
      Noninterest bearing accounts                      $      8,623,397              -- %
      Interest bearing accounts:                                                              
          Checking accounts                                   25,080,180             2.29%
          Money market accounts                               13,238,368             3.93%
    Passbook and statement savings accounts                   28,091,013             2.84%
    Certificates of deposit                                  160,660,757             5.28%
                                                        ----------------    ----------------- 
               Total                                    $    235,693,715             4.40%
                                                        ================    =================
SEPTEMBER 30, 1997
                                                        ------------------------------------- 
                                                                                 WEIGHTED    
                                                             BALANCE           AVERAGE RATE  
                                                        ----------------    -----------------
Transactions accounts:                                                        
      Noninterest bearing accounts                      $      6,546,032               -- %
      Interest bearing accounts:                                                              
          Checking accounts                                   24,149,622              2.32%
          Money market accounts                               11,117,680              3.64%
    Passbook and statement savings accounts                   27,699,834              2.84%
    Certificates of deposit                                  159,827,435              5.33%
                                                        ----------------    -----------------
               Total                                    $    229,340,603              4.48%
                                                        ================    =================
Time deposits with balances of $100,000 or greater totaled approximately  
     $29,700,000 and $29,579,000 at September 30, 1998 and 1997, respectively. 

                                     F-16                            (Continued)
1ST STATE BANK AND SUBSIDIARY

                  Notes to Consolidated Financial Statements

                       September 30, 1998, 1997 and 1996

                  (With Independent Auditors' Report Thereon)

                                                                             
     At September 30, 1998, the scheduled maturities of certificate accounts
     were as follows:
Year ending September 30,
            1999                                       $   116,528,391
            2000                                            25,212,621
            2001                                            10,643,247
            2002                                             4,052,541
            2003                                             4,188,260
            2004                                                35,697
                                                       ---------------

           Total                                       $   160,660,757
                                                       ===============
Interest expense on deposit accounts is summarized below:
YEARS ENDED SEPTEMBER 30,
                                                        1998             1997             1996
                                                   --------------    -------------   --------------
Interest-bearing transaction accounts          $   1,004,155          898,330          770,911
     Passbook and statement savings accounts              797,752          815,816          827,802
     Certificate accounts                               8,529,092        8,028,892        7,851,701
                                                    --------------   -------------    -------------- 
             Total                                  $  10,330,999        9,743,038        9,450,414
                                                    ==============   =============    ==============
On September 30, 1996, Congressional legislation was passed allowing a
     special assessment to be levied by the FDIC to recapitalize the Savings
     Association Insurance Fund ("SAIF"). The special assessment was based on
     the level of SAIF deposits a financial institution had as of March 31, 1995
     subject to a 20% reduction for certain qualifying deposits. The Bank's
     special assessment in 1996 totaled $1,283,320.

(8)  ADVANCES FROM FEDERAL HOME LOAN BANK OF ATLANTA

     Advances from the FHLB of Atlanta at September 30, 1998 and 1997 totaled
     $20,000,000 and $1,000,000, respectively, at an interest rate of 5.39% and
     5.57%, respectively. These advances will mature on February 13, 2008.

     At September 30, 1998 and 1997, the Bank had pledged all of its stock in
     the FHLB (see note 5) and entered into a security agreement with a blanket
     floating lien pledging all of its real estate loans to secure potential
     borrowings. Under an agreement with the FHLB, the Bank must have
     unencumbered collateral with principal balances, when discounted at 75% of
     the unpaid principal, at least equal to 100% of the Bank's FHLB advances.

                                     F-17                            (Continued)
1ST STATE BANK AND SUBSIDIARY

                  Notes to Consolidated Financial Statements

                       September 30, 1998, 1997 and 1996

                  (With Independent Auditors' Report Thereon)

     Interest expense on FHLB advances during the years ended September 30,
     1998, 1997 and 1996 was $740,439, $55,910 and $3,152 respectively.

(9)  NET WORTH AND REGULATORY MATTERS

     At September 30, 1998, retained income-substantially restricted included
     approximately $4,188,000 for which no provision for Federal income tax has
     been made. This amount represents an allocation of income to bad debt
     deductions for income tax purposes only. Reduction of such an amount for
     purposes other than to absorb bad debt losses could create taxable income
     in certain remote instances, which would be subject to the then current
     corporate income tax rate.

     The Bank is regulated by the Federal Deposit Insurance Corporation ("FDIC")
     and the Administrator, Savings Institutions Division, North Carolina
     Department of Commerce ("the Administrator"). The Bank must comply with the
     capital requirements of the FDIC and the Administrator. The FDIC requires
     the Bank to maintain minimum ratios of Tier I capital to risk-weighted
     assets and total capital to risk-weighted assets of 4% and 8%,
     respectively. To be "well capitalized," the FDIC requires ratios of Tier I
     capital to risk-weighted assets and total capital to risk-weighted assets
     of 6% and 10%, respectively. Tier I capital consists of total net worth
     calculated in accordance with generally accepted accounting principles less
     intangible assets, and total capital is comprised of Tier I capital plus
     certain adjustments, the only one of which applicable to the Bank is the
     allowance for loan losses. Risk-weighted assets reflect the Bank's on- and
     off-balance sheet exposures after such exposures have been adjusted for
     their relative risk levels using formulas set forth in FDIC regulations.
     The Bank is also subject to a leverage capital requirement, which calls for
     a minimum ratio of Tier I capital (as defined above) to quarterly average
     total assets of 3%, and a ratio of 5% to be "well capitalized." The
     Administrator requires a net worth equal to at least 5% of assets.

     As summarized below, at September 30, 1998 and 1997, the Bank was in
     compliance with all of the aforementioned capital requirements.

     At September 30, 1998, the FDIC categorized the Bank as "well capitalized"
     under the regulatory framework for prompt corrective action. There are no
     events or conditions since the notification that management believes have
     changed the Bank's category.

                                     F-18                           (Continued)
1ST STATE BANK AND SUBSIDIARY

                  Notes to Consolidated Financial Statements

                       September 30, 1998, 1997 and 1996

                  (With Independent Auditors' Report Thereon)

     As of September 30:
MINIMUM RATIOS
                                                                                    ------------------------------------
                                                                                                          TO BE "WELL
                                                                                      FOR CAPITAL       CAPITALIZED" FOR
                                         CAPITAL AMOUNT              RATIO              ADEQUACY       PROMPT CORRECTIVE
                                      ---------------------  --------------------                
                                         1998       1997        1998      1997          PURPOSES        ACTION PURPOSES
                                      ---------  ----------  ---------  ---------   ---------------    -----------------
                                          (in thousands)
Tier I Capital (to risk- 
          weighted assets)            $ 25,873     23,049       14.53%    14.05%          4.00%                 6.00%     
     Total Capital - Tier II                                                                                              
          (to risk-weighted                                                                                               
          assets)                       28,112     25,108       15.78%    15.30%          8.00%                10.00%     
     Leverage - Tier I capital                                                                                            
          (to average assets)           25,873     23,049        9.13%     9.02%          4.00%                 5.00%     
     Total Capital - (to                                                                                                  
          fourth quarter                                                                                                  
          average assets)               28,112     25,108        9.92%     9.82%          3.00%                 5.00%
(10) INCOME TAXES

     Components of income tax expense (benefit) consist of the following:
YEAR ENDED SEPTEMBER 30,
                                                   1998                 1997                1996
                                             ----------------     ----------------    ----------------
Currently payable:
          Federal                             $  1,804,000              1,221,100             657,500 
          State                                    159,000                 87,000              11,000 
                                               ------------         --------------      --------------
                                                 1,963,000              1,308,100             668,500 
                                               ------------         --------------      --------------
                                                                                                      
     Deferred:                                                                                        
          Federal                                 (486,000)               139,000             172,000 
          State                                   (115,000)                    --                  -- 
                                               ------------         --------------      --------------
                                                  (601,000)               139,000             172,000 
                                               ------------         --------------      --------------
               Total                          $  1,362,000              1,447,100             840,500 
                                               ============         ==============      ==============
Other assets include current income taxes receivable of $251,000 at
     September 30, 1998. Other liabilities include current income taxes payable
     of $76,000 at September 30, 1997. 

                                     F-19                            (Continued)
1ST STATE BANK AND SUBSIDIARY

                  Notes to Consolidated Financial Statements

                       September 30, 1998, 1997 and 1996

                  (With Independent Auditors' Report Thereon)

   A reconciliation of reported income tax expense for the years ended September
   30 1998 and 1997, to the amount of the income tax expense computed by
   multiplying income before income taxes by the statutory federal income tax
   rate of 34% follows:
1998       1997       1996
                                                 ---------  ---------  ---------
Income tax expense at statutory rate           $ 1,320,000  1,359,000    828,500
Increase in income taxes resulting from:                        
  State income taxes, net of federal benefit        29,000     57,000      7,000
  Other                                             13,000     31,100      5,000
                                                 ---------  ---------  ---------
                      Income tax expense       $ 1,362,000  1,447,100    840,500
                                                 =========  =========  =========
The significant components of deferred tax assets (liabilities) which are 
included in other assets, at September 30, 1998 and 1997, respectively, are:
1998                 1997
                                                                                ----------------     ----------------
Deferred tax assets:
     Allowance for loan losses                                                 $       1,079,000              851,000
     Loan fees deferred for financial reporting, net                                      52,000               49,000
     Deferred compensation                                                               750,000              369,000
     Other than temporary declines in value of
         securities available for sale                                                    97,000                   --
     Unrealized gains on investments securities available for sale                            --               47,000
     Other                                                                                 3,000                4,000
                                                                                ----------------     ---------------- 
                      Total gross deferred tax assets                                  1,981,000            1,320,000
                                                                                ----------------     ---------------- 
                      Less valuation allowance                                                --                   --
                                                                                ----------------     ---------------- 
                      Deferred tax assets net of valuation allowance                   1,981,000            1,320,000
                                                                                ----------------     ---------------- 
Deferred tax liabilities:
     Depreciable basis of fixed assets                                                  (288,000)            (270,000)
     Tax basis of FHLB stock                                                            (179,000)            (168,000)
     Loan fees                                                                          (231,000)            (158,000)
     Unrealized losses on investment securities available for sale                       (59,000)                  --
     Other                                                                               (17,000)             (12,000)
                                                                                ----------------     ---------------- 
                      Total gross deferred tax liabilities                              (774,000)            (608,000)
                                                                                ----------------     ---------------- 
                      Net deferred tax asset                                   $       1,207,000              712,000
                                                                                ================     ================
F-20                            (Continued)
1ST STATE BANK AND SUBSIDIARY

                  Notes to Consolidated Financial Statements

                       September 30, 1998, 1997 and 1996

                  (With Independent Auditors' Report Thereon)

     There is no valuation allowance for deferred tax assets as it is
     management's contention that realization of the deferred tax assets is more
     likely than not based upon the Bank's history of taxable income and
     estimates of future taxable income.

     The Bank is permitted under the Internal Revenue Code to deduct an annual
     addition to a reserve for bad debts in determining taxable income, subject
     to certain limitations. This addition differs significantly from the
     provisions for loan and real estate owned losses for financial reporting
     purposes. Under FASB 109, the Bank is not required to provide a deferred
     tax liability for the tax effect of additions to the tax bad debt reserve
     through 1987, the base year. Retained income at September 30, 1998,
     includes approximately $4,188,000 for which no provision for federal income
     tax has been made. These amounts represent allocations of income to bad
     debt deductions for tax purposes only. Reductions of such amounts for
     purposes other than tax bad debt losses could create income for tax
     purposes in certain remote instances, which would be subject to the then
     current corporate income tax rate.

(11) RETIREMENT PLANS

     The Bank has two defined contribution retirement plans covering
     substantially all of its employees. Retirement costs are funded as accrued.
     Contributions to the plans are determined based upon specified percentages
     of annual salaries. Retirement expense for the years ended September 30,
     1998, 1997, and 1996 was approximately $191,000, $207,000 and $215,000,
     respectively.

     Directors and certain executive officers participate in a deferred
     compensation plan which was approved by the Board of Directors on September
     24, 1997. This plan generally provides for fixed payments beginning at age
     62. The plan provides for past service credits of up to nine years, with
     vesting of 100% and 60% at September 30, 1998 and 1997, respectively. In
     addition, an annual amount will be credited to the participants accounts in
     subsequent years which will be fully vested at all times. In future years,
     directors may elect to defer directors' fees and executive officers may
     defer 25% of their salary and 100% of bonus compensation. The expense
     related to these plans for the years ended September 30, 1998 and 1997 was
     $986,663 and $1,085,000, respectively, and is included in compensation
     expense. The related liabilities at September 30, 1998 and 1997 of
     approximately $1,085,000 and $2,072,000, respectively, are included in
     other liabilities.

                                     F-21
1ST STATE BANK AND SUBSIDIARY

                  Notes to Consolidated Financial Statements

                       September 30, 1998, 1997 and 1996

                  (With Independent Auditors' Report Thereon)

(12) LEASING ARRANGEMENTS

     Rental expense was approximately $33,000 and $35,000 for the years ended
     September 30, 1998 and 1997, respectively. All leases are accounted for as
     operating leases. Minimum annual rents under noncancelable operating leases
     with remaining terms in excess of one year at September 30, 1998 are as
     follows:
OFFICE    
                                                    PROPERTIES   
                                                  --------------
Year ending September 30,                                 
                 1999                            $      15,000
                 2000                                   17,250
                 2001                                   18,000
                 2002                                   18,000
                 2003                                   18,000
                Thereafter                             127,500
                                                  -------------- 
                 Total                           $     213,750 
                                                  ==============
(13) FAIR VALUE OF FINANCIAL INSTRUMENTS

     SFAS No. 107, "Disclosures about Fair Value of Financial Instruments,"
     requires a company to disclose the fair value of its financial instruments,
     whether or not recognized in the balance sheet, where it is practical to
     estimate that value.

     The fair value estimates are made at a specific point in time based on
     relevant market information about the financial instrument. These estimates
     do not reflect any premium or discount that could result from offering for
     sale at one time the Bank's entire holding of a particular financial
     instrument. In cases where quoted market prices are not available, fair
     value estimates are based on judgments regarding current economic
     conditions, risk characteristics of various financial instruments, and
     other factors. These estimates are subjective in nature and involve
     uncertainties and matters of significant judgment and, therefore, cannot be
     determined with precision. Changes in assumptions could significantly
     affect the estimates. In addition, the tax ramifications related to the
     realization of the unrealized gains and losses can have a significant
     effect on fair value estimates and have not been considered in the
     estimates. Finally, the fair value estimates presented herein are based on
     pertinent information available to management as of September 30, 1998 and
     1997, respectively. Such amounts have not been comprehensively revalued for
     purposes of these financial statements since those dates and, therefore,
     current estimates of fair value may differ significantly from the amounts
     presented herein.

                                     F-22                            (Continued)
1ST STATE BANK AND SUBSIDIARY

                  Notes to Consolidated Financial Statements

                       September 30, 1998, 1997 and 1996

                  (With Independent Auditors' Report Thereon)

     The following methods and assumptions were used by the Bank in estimating
     its fair value disclosures for financial instruments:

     (A)  CASH AND CASH EQUIVALENTS

          The carrying amounts reported in the balance sheet for cash and cash
          equivalents approximate those assets' fair values.

     (B)  INVESTMENT SECURITIES

          Fair values were based on quoted market prices, where available. If
          quoted market prices were not available, fair values were based on
          quoted market prices of comparable instruments.

     (C)  LOANS RECEIVABLE

          The carrying values of variable-rate loans and other loans with short-
          term characteristics were considered to approximate the fair values.
          For other loans, the fair values were calculated using discounted cash
          flow analyses, using interest rates currently being offered for loans
          with similar terms and credit quality.

     (D)  DEPOSIT ACCOUNTS

          The fair value of deposits with no stated maturity, such as
          noninterest-bearing demand deposits, NOW, passbook, and money market
          deposits, was, by definition, equal to the amount payable on demand as
          of September 30, 1998 and 1997, respectively. The fair value of
          certificates of deposit was estimated using discounted cash flow
          analyses, using interest rates currently offered for deposits of
          similar remaining maturities.

     (E)  ADVANCES FROM THE FHLB

          The fair value of advances from the FHLB was estimated using
          discounted cash flow analyses, using interest rates currently offered
          for advances of similar remaining maturities.

                                      F-23                           (Continued)
1ST STATE BANK AND SUBSIDIARY

                  Notes to Consolidated Financial Statements

                       September 30, 1998, 1997 and 1996

                  (With Independent Auditors' Report Thereon)

The estimated fair values of financial instruments are as follows:
SEPTEMBER 30, 1998
                                                                  ------------------------------------
                                                                       CARRYING           ESTIMATED
                                                                        VALUE             FAIR VALUE
                                                                  ----------------    ----------------
Financial Assets:
     Cash and cash equivalents                                   $      31,077,054          31,077,054
     Investment securities                                              40,052,874          40,273,227
     Loans held for sale                                                 7,539,919           8,192,660
     Loans receivable, net of allowance for loan losses                196,782,275         201,783,429
     Federal Home Loan Bank stock                                        1,346,500           1,346,500
                                                                  ================    ================
                                                                 
Financial Liabilities:                                           
     Deposit accounts                                            $     235,693,715         235,904,989
     Advances from the Federal Home Loan Bank                           20,000,000          21,038,755
                                                                  ================    ================
SEPTEMBER 30, 1997
                                                                  ------------------------------------
                                                                       CARRYING           ESTIMATED
                                                                        VALUE             FAIR VALUE
                                                                   ----------------    ----------------
Financial Assets:
     Cash and cash equivalents                                   $      14,990,413          14,990,413
     Investment securities                                              34,801,287          34,859,547
     Loans held for sale                                                   684,438             684,438
     Loans receivable, net of allowance for loan losses                197,121,798         197,864,510
     Federal Home Loan Bank stock                                        1,281,200           1,281,200
                                                                  ================    ================
                                                                 
Financial Liabilities:                                           
     Deposit accounts                                            $     229,340,603         229,704,672
     Advances from the Federal Home Loan Bank                            1,000,000           1,000,000
                                                                  ================    ================
At September 30, 1998 and 1997, the Bank had outstanding commitments to
originate new loans and to extend credit. These off-balance sheet financial
instruments were exercisable at the market rate prevailing at the date the
underlying transaction will be completed and, therefore, they were deemed to
have no current fair market value.

SFAS 107 excludes certain financial instruments and all non-financial
instruments from its disclosure requirements. The disclosures also do not
include premises and equipment and certain intangible assets, such as customer
relationships. Accordingly, the aggregate fair value amounts presented above do
not represent the underlying value of the Bank.

                                     F-24
GLOSSARY

APB                      Accounting Principles Board

Administrator            Administrator, Savings Institutions Division, North
                         Carolina Department of Commerce

Bank                     1st State Bank, a North Carolina-chartered mutual
                         savings bank

Bank Conversion          The conversion of 1st State Bank, Inc. from a North
                         Carolina-chartered stock savings bank to a North
                         Carolina-chartered commercial bank

BIF                      Bank Insurance Fund of the FDIC

Commission               State Banking Commission of North Carolina, as well as
                         the State Banking Commissioner of North Carolina, whose
                         powers are exercised under the supervision of the
                         Commission

Community Offering       Offering for sale to certain members of the general
                         public of any shares of common stock not subscribed for
                         in the Subscription Offering, including the possible
                         offering of common stock in a Syndicated Community
                         Offering

Company                  1st State Bancorp, Inc., a Virginia corporation

Conversion               The Stock Conversion and the Bank Conversion

Converted Bank           As the case may be, 1st State Bank, Inc., a North
                         Carolina-chartered stock savings bank to be formed upon
                         the consummation of the Stock Conversion or 1st State
                         Bank, a North Carolina-chartered commercial bank to be
                         formed upon consummation of the Bank Conversion
 
Eligible Account         Savings account holders of 1st State Bank with account
Holders                  balances of at least $50.00 as of the close of business
                         on December 31, 1994
 
ESOP                     Employee Stock Ownership Plan of the Company

Estimated                Estimated pro forma market value of the Converted Bank
Valuation Range          ranging from $25.5 million to $34.5 million
 
Exchange Act             Securities Exchange Act of 1934, as amended
 
Expiration Date          12:00 Noon, Eastern Time, on ___________, 1999

FASB                     Financial Accounting Standards Board

FDIC                     Federal Deposit Insurance Corporation

Federal Reserve Board    The Board of Governors of the Federal Reserve System

Ferguson                 Ferguson & Company

                                      A-1
FHLB                     Federal Home Loan Bank

FHLMC                    Federal Home Loan Mortgage Corporation

FNMA                     Federal National Mortgage Association

Foundation               1st State Bank Foundation, Inc., a North Carolina
                         nonstock corporation dedicated to charitable and
                         community service causes within our market area

GNMA                     Government National Mortgage Association

IRA                      Individual retirement account or arrangement

IRS                      Internal Revenue Service

MRP                      Management recognition plan to be adopted no earlier
                         than six months after the conversion

NASD                     National Association of Securities Dealers, Inc.

National Market          National Market System operated by Nasdaq

NOW account              Negotiable order of withdrawal account

NPV                      Net portfolio value

Offering                 Subscription, Community and Syndicated Community
                         Offerings, collectively

Option Plan              Stock option plan of the Company to be adopted no
                         earlier than six months after the Conversion

Order Form               Form for ordering stock accompanied by a certification
                         concerning certain matters

Other Members            Savings account holders (other than Eligible Account
                         Holders and Supplemental Eligible Account Holders) and
                         borrowers whose loans were outstanding on the Voting
                         Record Date who are entitled to vote at the Special
                         Meeting due to the existence of a savings account or a
                         borrowing, respectively, on the Voting Record Date for
                         the Special Meeting

Plan                     Plan of Conversion of 1st State Bank to effect the
                         Stock Conversion and the Bank Conversion

Purchase Price           $20.00 per share price of the common stock

SAIF                     Savings Association Insurance Fund of the FDIC

SEC                      Securities and Exchange Commission

Securities Act           Securities Act of 1933, as amended

SFAS                     Statement of Financial Accounting Standards adopted by
                         FASB

                                      A-2
Special Meeting          Special Meeting of members of 1st State Bank called for
                         the purpose of approving the Plan of Conversion

Stock Conversion         Simultaneous conversion of 1st State Bank to a North
                         Carolina-chartered stock savings bank, the issuance of
                         the Converted Bank's outstanding capital stock to the
                         Company and the Company's offer and sale of its common
                         stock in the Offering

Subscription Offering    Offering of non-transferable rights to subscribe for
                         common stock, in order of priority, to Eligible Account
                         Holders, tax-qualified employee plans, Supplemental
                         Eligible Account Holders and Other Members

Supplemental Eligible    Depositors, who are not Eligible Account Holders of 1st
Account Holders          State Bank, with account balances of at least $50.00 on
                         December 31, 1998

Syndicated Community     Offering of shares of common stock remaining unsold
Offering                 after the Subscription Offering and undertaken prior to
                         the end and as part of the Community Offering, and
                         which may, at our discretion, be made to the general
                         public on a best efforts basis by a selling group of
                         broker-dealers

Trident Securities       Trident Securities, Inc.

Voting Record Date       The close of business on ___________, 1999, the date
                         for determining members of 1st State Bank entitled to
                         vote at the Special Meeting

                                      A-3
No dealer, salesman or other person has been authorized to give any
  information or to make any representations not contained in this document in
  connection with the offering made hereby, and, if given or made, such
  information or representations must not be relied upon as having been
  authorized by 1st State Bank, the Company, or Trident Securities.  This
  document does not constitute an offer to sell, or the solicitation of an offer
  to buy, any of the securities offered hereby to any person in any jurisdiction
  in which such offer or solicitation would be unlawful.  Neither the delivery
  of this document by 1st State Bank, the Company, or Trident Securities nor any
  sale made hereunder shall in any circumstances create an implication that
  there has been no change in the affairs of 1st State Bank or the Company,
  since any of the dates as of which information is furnished herein or since
  the date hereof.

                            1ST STATE BANCORP, INC.

                     (Holding Company for 1st State Bank)

                            UP TO 2,133,750 SHARES
                                 COMMON STOCK

                                  PROSPECTUS

                           TRIDENT SECURITIES,  INC.

                            DATED __________, 1999

                 THESE SECURITIES ARE NOT DEPOSITS OR ACCOUNTS
                  AND ARE NOT FEDERALLY INSURED OR GUARANTEED.

                     DEALER PROSPECTUS DELIVERY OBLIGATION

  UNTIL ________ __, 1999 (90 DAYS AFTER THE DATE OF THIS PROSPECTUS), ALL
  DEALERS THAT EFFECT TRANSACTIONS IN THESE SECURITIES, WHETHER OR NOT
  PARTICIPATING IN THIS OFFERING, MAY BE REQUIRED TO DELIVER A PROSPECTUS.  THIS
  IS IN ADDITION TO THE DEALERS OBLIGATION TO DELIVER A PROSPECTUS WHEN ACTING
  AS UNDERWRITERS AND WITH RESPECT TO THEIR UNSOLD ALLOTMENTS OR SUBSCRIPTIONS.
PART II: INFORMATION NOT REQUIRED IN PROSPECTUS

ITEM 13.  OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION
Legal Fees and Expenses........................  $  160,000
          Printing, Postage and Mailing..................     150,000
          Appraisal and Business Plan Fees and Expenses..      35,000
          Conversion Agent Fees and Expenses.............      25,000
          Transfer Agent Fees and Stock Certificates.....      15,000
          Accounting Fees and Expenses...................     125,000
          Blue Sky Filing Fees and Expenses
            (including counsel fees).....................      15,000
          Filing Fees (Administrator, Commissioner,
             SEC, and NASD)..............................      50,000
       *  Underwriter's Fees and Expenses................     372,900
          Local Counsel..................................       5,000
          Other Expenses.................................      87,100
                                                           ----------
          Total..........................................  $1,040,000  **
                                                           ==========
-------------------------
*  Calculation of Trident Securities' commissions assumes that the midpoint of
   the Estimated Valuation Range is sold in the Stock Conversion, 8% of the
   stock is purchased by the ESOP and all of the shares are purchased in the
   Subscription Offering.

** Assumes sale of 1,500,000 shares (the midpoint of the Estimated Valuation
   Range).

ITEM 14.  INDEMNIFICATION OF DIRECTORS AND OFFICERS

INDEMNIFICATION OF DIRECTORS AND OFFICERS OF THE COMPANY

     The Amended and Restated Certificate of Incorporation of 1st State Bank
provides that, to the fullest extent permitted by the North Carolina Business
Corporation Act (the "NCBCA"), no person who serves as a director shall be
personally liable to the Savings Bank or any of its stockholders or otherwise
for monetary damages for breach of any duty as director.

     In addition, Article IX of the Amended and Restated Bylaws of the Converted
Bank state that any individual who at any time serves or has served as a
director, officer, employee or agent of the Converted Bank, and any individual
who serves or has served at the request of the Converted Bank as a director,
officer, partner, trustee, employee or agent of another corporation,
partnership, joint venture, trust or other enterprise, or as a trustee or
administrator under an employee benefit plan, shall have a right to be
indemnified by the Converted Bank to the fullest extent permitted by law against
liability and litigation expense arising out of such status or activities in
such capacity.  Article IX of the Amended and Restated Bylaws of the Commercial
Bank contain similar provisions.

     Sections 55-8-50 through 55-8-58 of the NCBCA contain provisions
prescribing the extent to which directors and officers of the Converted Bank and
the Commercial Bank shall or may be indemnified. Section 55-8-51 of the NCBCA
permits a corporation, with certain exceptions, to indemnify a present or former
director against liability if (i) the director conducted himself in good faith,
(ii) the director reasonably believed (x) that the director's conduct in the
director's official capacity with the corporation was in its best interests and
(y) in all other cases the director's conduct was at least not opposed to the
corporation's best interests, and (iii) in the case of any criminal proceeding,
the director had no reasonable cause to believe the director's conduct was
unlawful. A corporation may not indemnify a director in connection with a
proceeding by or in the right of the corporation in which the director was
adjudged liable to the corporation or in connection with a proceeding charging
improper personal benefit to the director. The above standard of conduct is
determined by a majority vote of a quorum of the board of directors consisting
of directors not at the time

                                      II-1
parties to the proceeding, or majority vote of a duly designated committee of
the board of directors, special legal counsel, or the shareholders as prescribed
in Section 55-8-55.

     Sections 55-8-52 and 55-8-56 of the NCBCA require a corporation to
indemnify a director or officer in the defense of any proceeding to which the
director or officer was a party against reasonable expenses when the director or
officer is wholly successful in the director's or officer's defense, unless the
articles of incorporation provide otherwise.  Upon application, the court may
order indemnification of the director or officer if the director or officer is
adjudged fairly and reasonably so entitled under Section 55-8-54.

     In addition, Section 55-8-57 of the NCBCA permits a corporation to provide
for indemnification of directors, officers, employees or agents, in its articles
of incorporation or bylaws or by contract or resolution, against liability in
various proceedings and to purchase and maintain insurance policies on behalf of
these individuals.  The Savings Bank currently maintains a directors and
officers liability insurance policy.

     Directors, officers and employees of the Company may be entitled to benefit
from the indemnification provisions contained in the Virginia Stock Corporation
Act (the "VSCA") and the Holding Company's Articles of Incorporation.  The
general effect of these provisions is summarized below.

     In accordance with Sections 13.1-696 through 13.1-704 of the VSCA, a
director or officer of the Company generally shall be indemnified in the defense
of a proceeding if they are successful.  A corporation may indemnify a director,
officer, employee or agent under the circumstances in the preceding sentence and
in other circumstances if (i) he conducted himself in good faith; and (ii) he
believed  (x) that his conduct in his official capacity with the corporation was
in its best interests and (y) in all other cases his conduct was at least not
opposed to the corporation's best interests, and (iii) in the case of any
criminal proceeding, he had no reasonable cause to believe that his conduct was
unlawful.  A corporation may not indemnify a director, officer, employee or
agent in connection with a proceeding by or in the right of the corporation in
which the individual was adjudged liable to the corporation or in connection
with a proceeding charging improper personal benefit to the individual.  The
above standard of conduct is determined by a majority vote of a quorum of the
board of directors consisting of directors not at the time parties to the
proceeding, or majority vote of a duly designated committee of the board of
directors, special legal counsel, or the shareholders as prescribed in Section
13.1-701.

     Sections 13.1-698 and  13.1-702 of the VSCA require a corporation to
indemnify a director or officer in the defense of any proceeding to which the
director or officer was a party against reasonable expenses when the director or
officer is wholly successful in the director's or officer's defense, unless the
articles of incorporation provide otherwise.  Upon application, the court may
order indemnification of the director or officer if the director or officer is
adjudged fairly and reasonably so entitled under Section 13.1-700.1.

     In addition, Section  13.1-704 of the VSCA permits a corporation to provide
for indemnification of directors, officers, employees or agents, in its articles
of incorporation or bylaws or by contract or resolution, against liability in
various proceedings and to purchase and maintain insurance policies on behalf of
these individuals, except an indemnity against willful misconduct or a knowing
violation of criminal law.

     Article XVI of the Holding Company's Articles of Incorporation provides
that the Holding Company shall indemnify, to the fullest extent permissible
under the VSCA, any individual who is or was a director, officer, employee or
agent of the Holding Company, and any individual who serves or served at the
Holding Company's request as a director, officer, partner, trustee, employee or
agent of another corporation, partnership, joint venture, trust, other
enterprise or employee benefit plan, in any proceeding in which the individual
is made a party as a result of his service in such capacity.  In addition, the
Holding Company must pay reasonable expenses incurred by any person identified
in the preceding sentence who is a party to a proceeding in advance of the final
disposition of the proceeding upon receipt by the Holding Company of:  (i) a
written affirmation by such person of his good faith belief that the standard of
conduct necessary for indemnification by the Holding Company as authorized in
Article XVI has been met; and (ii) 

                                      II-2
a written undertaking by or on behalf of such person to repay the amount if it
shall ultimately be determined that the standard of conduct has not been met.

     Article XVI further provides that the Holding Company shall purchase and
maintain insurance on behalf of any person who holds or who has held any
position as a director or officer of the Holding Company against any liability
incurred by him or her in any such position, or arising out of his status as
such, whether or not the Corporation would have power to indemnify him or her
against such liability under Article XVI.

     The engagement letter dated July 24, 1998, between the Savings Bank and
Ferguson provides for the indemnification of Ferguson and its employees under
certain circumstances, in connection with the appraisal services rendered under
the terms of that engagement letter.  The engagement letter dated July 27, 1998,
between the Savings Bank and Trident Securities provides for the indemnification
of Trident Securities and its controlling persons under certain circumstances,
in connection with the Conversion and Trident Securities' engagement under the
engagement letter.  The Sales Agency Agreement to be entered into between
Trident Securities and the Company will provide for the indemnification of
Trident Securities, its affiliates, and their respective officers, directors,
employees, agents and controlling persons under certain circumstances.

ITEM 15. RECENT SALES OF UNREGISTERED SECURITIES.

      Not applicable.

ITEM 16. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES:

     The exhibits and financial statement schedules filed as a part of this
registration statement are as follows:

     (a)  LIST OF EXHIBITS
 
     1.1     Engagement Letter with Trident Securities, Inc.
 
  *  1.2     Sales Agency Agreement with Trident Securities, Inc.
 
     2       Plan of Conversion (Exhibit A to Proxy Statement filed as Exhibit
             99.2)

     3.1     Articles of Incorporation of 1st State Bancorp, Inc.
 
     3.2     Bylaws of 1st State Bancorp, Inc.
 
     4       Form of Common Stock Certificate of 1st State Bancorp, Inc.
 
     5       Opinion of Housley Kantarian & Bronstein, P.C. regarding legality
             of securities being registered
             
     8.1     Form of Federal Tax Opinion
 
     8.2     Form of State Tax Opinion
 
     8.3     Opinion of Ferguson & Company as to the value of subscription
             rights for tax purposes

     10.1    Proposed 1st State Bancorp, Inc. 1999 Stock Option and Incentive
             Plan
 

                                      II-3
10.2    Proposed 1st State Bancorp, Inc. Management Recognition Plan
 
     10.3    Employment Agreements by and between 1st State Bank and James C.
             McGill, A. Christine Baker and Fairfax C. Reynolds
 
     10.4    Form of Guaranty Agreement by and between 1st State Bancorp, Inc.
             and James C. McGill, A. Christine Baker and Fairfax C. Reynolds
             
     10.5    1st State Bank Deferred Compensation Plan
 
     23.1    Consent of Housley Kantarian & Bronstein, P.C. (filed herewith and 
             contained in opinion filed as Exhibit 5)
               
     23.2    Consent of KPMG Peat Marwick LLP
 
     23.3    Consent of Ferguson & Company
 
     24      Power of Attorney (reference is made to the signature page of the
             Form S-1)

     27      Financial Data Schedule

     99.1    Form of Proposed Stock Order Form and Form of Certification
 
     99.2    Proxy Statement for Special Meeting of Members of 1st State Bank;
             Form of Proxy
             
     99.3    Miscellaneous Solicitation and Marketing Materials
 
*    99.4    Appraisal Report

____________
* To be filed by amendment.

     (b)  FINANCIAL STATEMENT SCHEDULES.

     No financial statement schedules are filed because the required information
is not applicable or is included in the consolidated financial statements or
related notes.

ITEM 17. UNDERTAKINGS

     The undersigned registrant hereby undertakes:

     (1) To file, during any period in which offers or sales are being made, a
post-effective amendment to this registration statement:

         (i)  To include any prospectus required by Section 10(a)(3) of the
     Securities Act of 1933;

         (ii) To reflect in the prospectus any facts or events arising after
     the effective date of the registration statement (or the most recent post-
     effective amendment thereof) which, individually or in the aggregate,
     

                                      II-4
represent a fundamental change in the information set forth in the
     registration statement. Notwithstanding the foregoing, any increase or
     decrease in volume of securities offered (if the total dollar value of
     securities offered would not exceed that which was registered) and any
     deviation from the low or high end of the estimated maximum offering range
     may be reflected in the form of prospectus filed with the Commission
     pursuant to Rule 424(b) if, in the aggregate, the changes in volume and
     price represent no more than 20 percent change in the maximum aggregate
     offering price set forth in the "Calculation of Registration Fee" table in
     the effective registration statement;

          (iii)  To include any material information with respect to the plan of
     distribution not previously disclosed in the registration statement or any
     material change to such information in the registration statement.

     (2)  That, for the purpose of determining any liability under the
Securities Act of 1933, each such post-effective amendment shall be deemed to be
a new registration statement relating to the securities offered therein, and the
offering of such securities at that time shall be deemed to be the initial bona
fide offering thereof.

     (3)  To remove from registration by means of a post-effective amendment any
of the securities being registered which remain unsold at the termination of the
offering.

     The undersigned registrant hereby undertakes to provide to the underwriter
at the closing specified in the underwriting agreements, certificates in such
denominations and registered in such names as required by the underwriter to
permit prompt delivery to each purchaser.

     Insofar as indemnification for liabilities arising under the Securities Act
of 1933 may be permitted to directors, officers and controlling persons of the
registrant pursuant to the foregoing provisions, or otherwise, the registrant
has been advised that in the opinion of the Securities and Exchange Commission
such indemnification is against public policy as expressed in the Act, and is
therefore, unenforceable.  In the event that a claim for indemnification against
such liabilities (other than the payment by the registrant of expenses incurred
or paid by a director, officer or controlling person of the registrant in the
successful defense of any action, suit or proceeding) is asserted by such
director, officer or controlling person in connection with the securities being
registered, the registrant will, unless in the opinion of its counsel the matter
has been settled by controlling precedent, submit to a court of appropriate
jurisdiction the questions whether such indemnification by it is against public
policy as expressed in the Act and will be governed by the final adjudication of
such issue.

                                      II-5
SIGNATURES

     Pursuant to the requirements of the Securities Act of 1933, as amended, the
registrant has duly caused this registration statement to be signed on its
behalf by the undersigned, thereunto duly authorized, in the City of Burlington,
State of North Carolina, on November 25, 1998.

                              1ST STATE BANCORP, INC.

                              By: /s/ James C. McGill
                                  -------------------------------
                                  James C. McGill
                                  President

                               POWER OF ATTORNEY

     We, the undersigned Directors of 1st State Bancorp, Inc., hereby severally
constitute and appoint James C. McGill, with full power of substitution, our
true and lawful attorney and agent, to do any and all things in our names in the
capacities indicated below which said James C. McGill may deem necessary or
advisable to enable 1st State Bancorp, Inc. to comply with the Securities Act of
1933, as amended, and any rules, regulations and requirements of the Securities
and Exchange Commission, in connection with the registration of 1st State
Bancorp, Inc. common stock, including specifically, but not limited to, power
and authority to sign for us in our names in the capacities indicated below, the
registration statement and any and all amendments (including post-effective
amendments) thereto; and we hereby ratify and confirm all that said James C.
McGill shall do or cause to be done by virtue thereof.

     Pursuant to the requirements of the Securities Act of 1933, as amended,
this registration statement has been signed below by the following persons in
the capacities and on the dates indicated.
Signatures                    Title                                               Date
   ----------                    -----                                               ----
/s/ James C. McGill            President, Chief Executive Officer               November 25, 1998
----------------------------
James C. McGill                and Director (Principal Executive Officer)
 
/s/ A. Christine Baker         Executive Vice President-Chief                   November 25, 1998
----------------------------
A. Christine Baker             Financial Officer, Secretary and
                               Treasurer (Principal Financial and
                               Accounting Officer)
 
/s/ Richard C. Keziah          Chairman of the Board                            November 25, 1998
----------------------------
Richard C. Keziah
 
/s/ James A. Barnwell, Jr.     Director                                         November 25, 1998
----------------------------
James A. Barnwell, Jr.
 
/s/ Bernie C. Bean             Director                                         November 25, 1998
----------------------------
Bernie C. Bean
 
/s/ James G. McClure           Director                                         November 25, 1998
----------------------------
James G. McClure
 
/s/ T. Scott Quakenbush        Director                                         November 25, 1998
----------------------------
T. Scott Quakenbush
 
/s/ Richard H. Shirley         Director                                         November 25, 1998
----------------------------
Richard H. Shirley
 
/s/ Virgil L. Stadler          Director                                         November 25, 1998
----------------------------
Virgil L. Stadler