<PAGE>
 
================================================================================
 
                       SECURITIES AND EXCHANGE COMMISSION
                            Washington, D.C.  20549
 
                                  FORM 10-KSB

(Mark One)
[X]          ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES 
             EXCHANGE ACT OF 1934
 
For the fiscal year ended December 31, 1998

                                      OR
 
[ ]          TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE 
             SECURITIES EXCHANGE ACT OF 1934
 
For the transition period from _______ to _______
        
                        Commission File Number: 0-23551

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


           Tennessee                                    62-1710108
_______________________________                     ___________________      
(State or other jurisdiction of                      (I.R.S. Employer 
incorporation or organization)                      Identification No.)         
                   

344 W. Broadway, Newport, Tennessee                     37821-0249
___________________________________                 -------------------
(Address of principal executive offices)                (Zip Code)


        The issuer's telephone number, including area code:  (423) 623-6088

      Securities registered under Section 12(b) of the Exchange Act:  None

      Securities registered under to Section 12(g) of the Exchange Act:  
                          Common Stock, no par value.

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

Check if there is no disclosure of delinquent filers in response to Item 405 of
Regulation S-B contained in this form, and no disclosure will be contained, to
the best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-KSB or any
amendment to this Form 10-KSB. [X]

The issuer's revenues for its most recent fiscal year were $5,949,793.

The aggregate market value of the outstanding common stock held by non-
affiliates at March 24, 1999 was approximately $12.5 million (based on 1,038,136
shares at the most recent trading price of which management was aware ($12.00 on
March 24, 1999)) (the registrant's employee stock ownership plan, directors'
retirement plan and directors and executive officers have not been deemed to be
non-affiliates).

The total number of outstanding shares of the issuer's common stock at March 24,
1999 was 1,382,013.

Transitional small business disclosure format (check one):  Yes        No    X  
                                                                -----      -----


                      DOCUMENTS INCORPORATED BY REFERENCE

     1. 1998 Annual Report to Stockholders (the "Annual Report") (Part II).

     2. Proxy Statement for 1999 Annual Meeting of Stockholders (the "Proxy
        Statement") (Part III).

================================================================================
<PAGE>
 
                                    PART I

Item 1.  Description of Business
--------------------------------

General

     United Tennessee Bankshares, Inc.   United Tennessee Bankshares, Inc. (the
"Company") was incorporated under the laws of the State of Tennessee in August
1997 to serve as the holding company for Newport Federal Bank (the "Bank")
following its conversion from mutual to stock form (the "Conversion").  On
January 1, 1998, the Bank consummated the Conversion, and the Company completed
its initial offering of Common Stock through the sale and issuance of 1,454,750
shares of Common Stock at a price of $10.00 per share, realizing gross proceeds
of $14.5 million and net proceeds of approximately $14.0 million.  The Company
purchased all of the Bank's capital stock with $7.1 million of the net offering
proceeds and retained the remainder.  Prior to January 1, 1998, the Company had
no assets or liabilities and engaged in no business activities.  Accordingly,
the information set forth in this report, including the audited financial
statements and related data for periods prior to January 1, 1998, relates
primarily to the Bank

     The Company's executive offices are located at 344 W. Broadway, Newport,
Tennessee 37821-0249, and its telephone number is (423) 623-6088.

     Newport Federal Bank. The Bank was organized in 1934 as a federally
chartered mutual savings institution under the name Newport Federal Savings and
Loan Association.  Effective January 1, 1998, the Bank became a stock savings
bank and changed its name to Newport Federal Bank.  The Bank currently operates
through three full service banking offices located in Newport, Tennessee.  At
December 31, 1998, the Bank had total assets of $92.3 million, deposits of $69.8
million and stockholders' equity of $13.9 million, or 15.1% of total assets.

     The Bank attracts deposits from the general public and invests those funds
in loans secured by first mortgages on owner-occupied single-family residences
in its market area and, to a lesser extent, commercial real estate loans and
consumer loans.  The Bank also maintains a substantial investment portfolio,
primarily of mortgage-backed securities issued by the FNMA, FHLMC and GNMA,
obligations of the federal government and agencies and investment-grade
obligations of states and political subdivisions.

     The Bank derives its income principally from interest earned on loans,
investment securities and other interest-earning assets.  The Bank's principal
expenses are interest expense on deposits and noninterest expenses such as
employee compensation, deposit insurance and miscellaneous other expenses.
Funds for these activities are provided principally by deposit growth,
repayments of outstanding loans and investment securities, other operating
revenues and, from time to time, advances from the Federal Home Loan Bank of
Cincinnati.

                                       1
<PAGE>
 
     As a federally chartered savings institution, the Bank is subject to
extensive regulation by the OTS.  The Bank's lending activities and other
investments must comply with various federal regulatory requirements, and the
OTS periodically examines the Bank for compliance with various regulatory
requirements.  The Bank must also file reports with the OTS describing its
activities and financial condition.  The Bank's deposits are insured to
applicable limits by the Savings Association  Insurance Fund ("SAIF") of the
Federal Deposit Insurance Corporation ("FDIC").  The Bank is also subject to
certain monetary reserve requirements promulgated by the Board of Governors of
the Federal Reserve System.

Market Area

     The Bank's primary market area is Cocke County, Tennessee.  To a lesser
extent, the Bank accepts deposits and offer loans in surrounding areas.

     Cocke County is primarily rural, with a population of approximately 32,000
persons and relatively high unemployment levels and low income levels.
Approximately one-third of the county is occupied by Douglas Lake and portions
of the Cherokee National Forest and the Great Smoky Mountains National Park.  In
recent periods, the population growth rate has been significantly above the
national rate and somewhat below the state rate (since 1990, 10.0% compared with
7.7% and 10.6%, respectively), partially due to increased numbers of retirees
moving into the area.  However, unemployment levels have been slightly higher
than state and national levels (for June 1998, 5.8% compared with 4.5% and 4.7%,
respectively), and income levels have been substantially lower than state and
national averages (for 1998, $20,200 compared with $25,700 and $29,300,
respectively, per person), due in part to the seasonal nature of tourism related
employment.  Over the next five years, demographic trends in the county are
expected to be consistent with recent experience, with the differences between
county, state and national population growth rates decreasing and the
differences between county, state and national income levels growing.

     The economy in the Bank's primary market area includes a variety of
industries, including farming, manufacturing, services, retail and wholesale
trade and tourism.  Significant employers include Hunt Wesson in the food
processing industry and Falcon Products in the furniture industry.

Competition

     The Bank experiences substantial competition both in attracting and
retaining savings deposits and in the making of mortgage and other loans.

     Direct competition for savings deposits comes from other savings
institutions, credit unions, regional bank holding companies and commercial
banks.  Significant competition for the Bank's other deposit products and
services comes from money market mutual funds and brokerage firms.  Its direct
competitors include three banks, one of which is a branch of a large regional
bank headquartered outside its market area, and one branch of a credit union
headquartered outside its market area.  The Bank currently has the third largest
share of deposits in its market area of Cocke 

                                       2
<PAGE>
 
County. The primary factors in competing for loans are interest rates and loan
origination fees and the quality and range of services offered by various
financial institutions. Competition for origination of real estate loans
normally comes from other savings institutions, commercial banks, credit unions,
mortgage bankers and mortgage brokers.

     The Bank's principal primary competition comes from financial institutions
headquartered in its primary market area and from various non-local commercial
banks that have branch offices located in its primary market area.  Many
competing financial institutions have financial resources substantially greater
than the Bank's and offer a wider variety of deposit and loan products.  The
Bank's principal competitive strategy has been to emphasize quality customer
service.

Lending Activities

     The Bank principally originates loans secured by mortgages on single-family
residences in its primary market area.  It also makes commercial real estate
loans and a variety of consumer loans.

     With certain limited exceptions, the maximum amount that a savings
institution may lend to any borrower (including certain related entities of the
borrower) at one time may not exceed 15% of the unimpaired capital and surplus
of the institution, plus an additional 10% of unimpaired capital and surplus for
loans fully secured by readily marketable collateral.  At December 31, 1998, the
maximum amount that the Bank could have lent to any one borrower without prior
OTS approval under those regulations was approximately $2.1 million.  At that
date, the largest aggregate amount of loans that the Bank had outstanding to any
one borrower was $1.5 million, a total of 11 lending relationships with
aggregate loan amounts over $250,000, and none of these loans were
nonperforming.   For additional information, see " -- Regulation of the Bank --
Limits on Loans to One Borrower."

                                       3
<PAGE>
 
     Loan Portfolio Composition.  The following table sets forth information
about the composition of the Bank's loan portfolio by type of loan at the dates
indicated.  At December 31, 1998, the Bank had no concentrations of loans
exceeding 10% of gross loans other than as disclosed below.
<TABLE>
<CAPTION>
 
                                                                At December 31,
                                             -----------------------------------------------------
                                                   1998                1997             1996        
                                             -----------------   ----------------  --------------
                                              Amount      %      Amount      %      Amount     %
                                             --------  -------  --------  -------  --------  -----
                                                            (Dollars in thousands)
<S>                                          <C>       <C>      <C>       <C>      <C>       <C>
 
Real estate loans:
 One- to four-family residential...........  $41,833     76.1%  $40,482     82.0%  $39,549   86.6%
 Commercial................................    7,267     13.2     3,493      7.1     2,265    5.0
 Construction..............................    3,235      5.9     3,266      6.6     1,889    4.1
 
Consumer loans:
 Automobile................................      813      1.5       646      1.3       664    1.4
 Loans to depositors, secured by deposits..      848      1.5       634      1.3       509    1.1
 Home equity and second mortgage...........      162      0.3       243      0.5       234    0.5
 Other.....................................      838      1.5       608      1.2       565    1.3
                                             -------   ------   -------   ------   -------   ----
                                              54,996    100.0%   49,372    100.0%   45,675  100.0%
                                             -------   ======   -------   ======   -------  =====
 
Less:
 Loans in process..........................      748              1,308                688
 Deferred fees and discounts...............      261                278                263
 Allowance for loan losses.................      641                628                494
                                             -------            -------            -------
  Total....................................  $53,346            $47,158            $44,230
                                             =======            =======            =======
 
</TABLE>

     Loan Maturity Schedule.  The following table sets forth information about
dollar amounts of loans maturing in the Bank's portfolio based on their
contractual terms to maturity, including scheduled repayments of principal, at
December 31, 1998.  Demand loans, loans having no stated schedule of repayments
and no stated maturity 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 all mortgage loans and may cause the repayment
experience of the Bank to differ from that shown below.

<TABLE>
<CAPTION>
 
                                                  Due after
                                      Due within  1 Through  Due After
                                        1 Year     5 Years    5 Years    Total
                                      ----------  ---------  ---------  -------
                                                   (In thousands)
<S>                                   <C>         <C>        <C>        <C>
 
Real estate loans:
   One- to four-family residential..      $  850     $1,347    $39,636  $41,833
   Commercial.......................          60        175      7,032    7,267
   Construction.....................       3,235         --         --    3,235
Consumer loans......................       1,298      1,295         68    2,661
                                          ------     ------    -------  -------
      Total.........................      $5,443     $2,817    $46,736  $54,996
                                          ======     ======    =======  =======
</TABLE>

                                       4
<PAGE>
 
     Loan Portfolio Sensitivity.  The following table sets forth information
about dollar amounts of loans due one year or more after December 31, 1998 that
had predetermined interest rates and that had adjustable interest rates at that
date.
<TABLE>
<CAPTION>
                                    Predetermined    Floating or
                                        Rate       Adjustable Rates
                                    -------------  ----------------
                                           (In thousands)
<S>                                 <C>            <C>

Real estate loans:
 One- to four-family residential..        $12,221           $28,762
 Commercial.......................          1,471             5,736
 Construction.....................             --                --
Consumer loans....................          1,363                --
                                          -------           -------
  Total...........................        $15,055           $34,498
                                          =======           =======
</TABLE>

     Scheduled contractual principal repayments of loans do not reflect the
actual life of such assets.  The average life of loans is substantially less
than their contractual terms because of prepayments.  In addition, due-on-sale
clauses on loans generally give the Bank the right to declare a loan immediately
due and payable in the event, among other things, that the borrower sells the
real property subject to the mortgage and the loan is not repaid.  The average
life of mortgage loans tends to increase when current mortgage loan 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.

     Loan Originations, Purchases and Sales.  The following table sets forth
information about its loan originations during the periods indicated.  The Bank
does not purchase or sell loans.
<TABLE>
<CAPTION>
                                                              Year Ended December 31,
                                                           ----------------------------
                                                             1998      1997      1996
                                                           --------  --------  --------     
Loans originated:                                                 (In thousands)
<S>                                                        <C>       <C>       <C>
  Real estate loans:
    One- to four-family residential.......                  $11,409   $ 7,169   $ 8,305
    Commercial............................                    4,750     1,393     1,439
    Construction..........................                    3,225     3,862     2,770
  Consumer loans..........................                    1,404     1,115     1,081
                                                            -------   -------   -------
     Total loans originated...............                   20,788    13,539    13,595
Loans acquired in branch purchases........                       26        --        --
                                                            -------   -------   -------
     Total loans originated and acquired..                  $20,814   $13,539   $13,595
                                                            =======   =======   =======
</TABLE>

     One- to Four-Family Residential Lending.  The Bank's principal lending
activity consists of  the origination of loans secured by mortgages on existing
single-family residences in its primary market area.  The Bank also originates
significant amounts of loans for the construction of such residences.  The
purchase price or appraised value of most of such residences generally has been
between $40,000 and $70,000, with original loan amounts averaging approximately
$45,000.  At 

                                       5
<PAGE>
 
December 31, 1998, $41.8 million, or 76.1%, of total loans were secured by one-
to four-family residences, a substantial majority of which were existing, owner-
occupied, single-family residences in its primary market area. At December 31,
1998, $30.2 million, or 72.2%, of its one- to four-family residential loans had
adjustable interest rates, and $11.6 million, or 27.8% had fixed rates. During
the year ended December 31, 1998, the Bank originated $8.9 million of 
adjustable-rate loans, which was approximately 78% of total mortgage loan
originations for that period, and at that date it had $1.5 million of loan
commitments, 75% of which were for adjustable rate loans.

     The Bank's one- to four-family residential mortgage loans may have
adjustable or fixed rates of interest.  These loans generally are for terms of
up to 25 years for adjustable-rate loans and 15 years for fixed-rate loans,
amortized on a monthly basis, with principal and interest due each month.
Residential real estate loans often remain outstanding for significantly shorter
periods than their contractual terms.  Borrowers may refinance or prepay loans
at their option without penalty.  These loans customarily contain "due-on-sale"
clauses which permit the Bank to accelerate repayment of a loan upon transfer of
ownership of the mortgaged property.

     While it is not the Bank's policy to sell its loans in the secondary
market, one- to four-family residential mortgage loans generally are
underwritten in accordance with applicable underwriting guidelines and
documentation requirements published by the FNMA and FHLMC for loans to be
eligible for sale to them, except, as to approximately 95% of these loans, with
respect to their requirements with respect to mortgaged properties (for example,
in light of the Bank's experience in its market area, the Bank often does not
require homes to have air conditioning or a complete survey or independent
appraisal, and occasionally does not require contractors to be licensed).

     The Bank's lending policies generally limit the maximum loan-to-value ratio
on one- to four-family residential mortgage loans secured by owner-occupied
properties to 95% of the lesser of the appraised value or purchase price, with
private mortgage insurance or other enhancement required on loans with loan-to-
value ratios in excess of 80%.  The maximum loan-to-value ratio on mortgage
loans secured by non-owner-occupied properties generally is limited to 75%.

     The Bank's adjustable-rate, one- to four-family residential mortgage loans
generally are indexed to the weekly average rate on U.S. Treasury securities
adjusted to a constant maturity of one year.  The rates at which interest
accrues on these loans typically are adjustable annually, often after an initial
period of up to five years before the first rate adjustment, generally with
limitations on adjustments of two percentage points per adjustment period, and
six percentage points over the life of the loan, and an interest rate floor
equal to the initial interest rate on the loan.  While its adjustable-rate loans
frequently are originated with initially discounted interest rates, such loans
are underwritten and borrowers are qualified based on the fully indexed interest
rate.  The Bank's adjustable-rate loans do not permit negative amortization.

     Adjustable-rate loans help the Bank to reduce its exposure to increases 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 

                                       6
<PAGE>
 
periods of rising interest rates, the risk of default on adjustable-rate loans
may increase due to increases in interest costs to borrowers. Further,
adjustable-rate loans which provide for initial rates of interest below the
fully indexed rates may be subject to increased risk of delinquency or default
as the higher, fully indexed rate of interest subsequently replaces the lower,
initial rate. Further, although adjustable-rate loans allow the Bank to increase
the sensitivity of its 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 periodic and lifetime interest rate
adjustment limitations and the ability of borrowers to refinance the loans.
Accordingly, no assurance can be given that yields on its adjustable-rate loans
will fully adjust to compensate for increases in its cost of funds. Finally,
adjustable-rate loans increase the Bank's exposure to decreases in prevailing
market interest rates, although decreases in its cost of funds and its interest
rate adjustment limitations and floor tend to offset this effect.

     Construction Lending.  The Bank offers loans to individuals for
construction of one- to four-family owner-occupied residences located in its
primary market area, with such loans usually converting to permanent financing
upon completion of construction.  At December 31, 1998, the Bank's loan
portfolio included $3.2 million of loans secured by properties under
construction, all of which were construction/permanent loans structured to
become permanent loans upon the completion of construction.  From time to time,
the Bank also offers loans to qualified builders for the construction of one- to
four-family residences located in the Bank's primary market area.  Because such
homes are intended for resale, the Bank generally does not cover such loans by
permanent financing commitments.   All construction loans are secured by a first
lien on the property under construction.  Loan proceeds are disbursed in
increments as construction progresses and as inspections warrant.
Construction/permanent loans are underwritten in accordance with the same
requirements as  permanent mortgages, except the loans generally provide for
disbursement in stages during a construction period of up to six months, during
which period the borrower may or may not be required to make monthly payments.
Borrowers must satisfy all credit requirements that would apply to its permanent
mortgage loan financing prior to receiving construction financing for the
subject property.

     Construction financing involves a higher degree of risk of loss than long-
term financing on existing, improved, occupied real estate.  Risk of loss on a
construction loan depends upon the accuracy of the initial estimate of the
property's value at completion of construction and the estimated cost (including
interest) of construction.  During the construction phase, a number of factors
could cause delays and cost overruns.  If the estimate of construction costs is
inaccurate, it may be required to advance funds beyond the amount originally
committed to permit completion of construction.  If the estimate of value is
inaccurate, it may be confronted, at or prior to the maturity of the loan, with
a property having a value which is insufficient to assure full repayment.  The
ability of a builder to sell completed residences will depend on, among other
things, demand, pricing, availability of comparable properties and economic
conditions.  The Bank has tried to minimize this risk by limiting construction
lending to qualified borrowers in its market area and by limiting the aggregate
amount of outstanding construction loans.

                                       7
<PAGE>
 
     Commercial Real Estate Lending.  The Bank originates limited amounts of
commercial real estate loans in order to benefit from the higher origination
fees and interest rates, as well as shorter terms to maturity, than could be
obtained from single-family mortgage loans.  The Bank's commercial real estate
loans are secured by churches, restaurants, offices, apartments and other
income-producing commercial properties.  At December 31, 1998, the Bank had 96
of these loans totaling $7.3 million, with a median loan balance of
approximately $75,000, none of which had a balance exceeding $750,000.   None of
these loans was classified as substandard, doubtful or loss or designated as
special mention at that date.  For information about its asset classification
policies and nonperforming assets, see " -- Asset Classification, Allowance for
Losses and Nonperforming Assets."

     The Bank's commercial real estate loans generally are limited to original
balances not exceeding $500,000 on properties in its primary market area, with
terms of up to 25 years.  These loans generally have annually adjustable
interest rates, with limitations on adjustments of two percent per year, and
maximum loan-to-value ratios of 75%.

     The following paragraphs set forth information about the Bank's commercial
real estate loans with outstanding balances exceeding $500,000 at December 31,
1998.  None of these loans was classified as substandard, doubtful or loss or
designated as special mention at that date.  For information about asset
classification policies of the Bank, see "Asset Classification, Allowance for
Losses and Nonperforming Assets."

          Retail properties in Sevierville, Tennessee.  In December 1998, the
          -------------------------------------------                        
          Bank made a $750,000 loan secured by a medical office building.  The
          appraisal indicated a loan-to-value ratio of approximately 67%.  The
          loan is being amortized over 15 years.

          Retail properties in Sevierville, Tennessee.  In December 1998, the
          -------------------------------------------                        
          Bank made a $750,000 loan secured by an office building located in
          Sevierville, Tennessee.  The appraisal indicated a loan-to-value ratio
          of approximately 75%.  The loan is being amortized over 15 years.

     Commercial real estate lending entails significant additional risks
compared with single-family residential lending.  For example, commercial real
estate loans typically involve large 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, and these
risks can be significantly impacted by supply and demand conditions in the
market for multi-family residential units and commercial office space, and, as
such, may be subject to a greater extent to adverse conditions in the economy
generally.  In addition, church loans may depend on the congregation's voluntary
contributions, which may be affected by local employment levels and other
factors.  To minimize the effects of these risks, the Bank generally limits
commercial real estate lending to its primary market area and to borrowers with
which it has substantial experience or who are otherwise well known to the Bank.
It is the Bank's policy to obtain personal guarantees from all principals

                                       8
<PAGE>
 
obtaining commercial real estate loans.  In assessing the value of such
guarantees, the individual's personal financial statements, credit reports, tax
returns and other financial information are reviewed.

     The aggregate amount of loans which federally chartered savings
institutions may make on the security of liens on commercial real estate may not
exceed 400% of the institution's capital.  Based on its total capital at
December 31, 1998, the Bank would be permitted to invest up to $46.2 million in
loans secured by commercial real estate.

     Consumer Lending.  The Bank's consumer loans consist of automobile loans,
demand loans secured by deposit accounts with the Bank, home equity loans
secured by second mortgages on single-family residences in the Bank's market
area and other loans.  These loans totaled approximately $2.7 million at
December 31, 1998.  At that date, the Bank had 422 consumer loans, with a median
loan balance of approximately $5,000, none of which had a balance exceeding
$75,000, and none of the ten largest consumer loans was adversely classified or
designated.

     Consumer loans generally involve more risk than first mortgage loans.
Repossessed collateral for a defaulted loan may not provide an adequate source
of repayment of the outstanding loan balance as a result of damage, loss or
depreciation, and the remaining deficiency often does not warrant further
substantial collection efforts against the borrower.  In addition, loan
collections are dependent on the borrower's continuing financial stability, and
thus are more likely to be adversely affected by job loss, divorce, illness or
personal bankruptcy.  Further, the application of various federal and state
laws, including federal and state bankruptcy and insolvency laws, may limit the
amount which can be recovered.  These loans may also give rise to claims and
defenses by a borrower against the Bank, and a borrower may be able to assert
claims and defenses which the Bank has against the seller of the underlying
collateral.  In underwriting consumer loans, the Bank considers the borrower's
credit history, an analysis of the borrower's income, expenses and ability to
repay the loan and the value of the collateral.

     Collection Policies.  When a borrower fails to make a payment on a loan,
the Bank generally takes prompt steps to have the delinquency cured and the loan
restored to current status.  Once the payment grace period has expired (in most
instances 15 days after the due date), a late charge is imposed, if applicable.
If payment is not promptly received, a notice is sent 15 days after the
expiration of the grace period.  If the loan becomes 60 days delinquent, the
borrower is contacted and an attempt is made to formulate an affirmative plan to
cure the delinquency.  If a loan becomes 90 days delinquent, the loan is
reviewed, and, if payment is not made, the Bank pursues foreclosure or other
appropriate action.

     Asset Classification, Allowance for Losses and Nonperforming Assets.
Federal regulations require savings institutions to classify their assets on the
basis of quality on a regular basis.  An asset is classified as substandard if
it is determined to be inadequately protected by the current net worth and
paying capacity of the obligor or of the collateral pledged, if any.  An asset
is classified as doubtful if full collection is highly questionable or
improbable.  An asset is classified as loss if it is considered uncollectible,
even if a partial recovery could be expected in the future.  The regulations

                                       9
<PAGE>
 
also provide for a special mention designation, described as assets which do not
currently expose an institution to a sufficient degree of risk to warrant
classification but do possess credit deficiencies or potential weaknesses
deserving its close attention.  Assets classified as substandard or doubtful
require an institution to establish general allowances for loan losses.  If an
asset or portion thereof is classified loss, an 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.  Federal examiners may
disagree with an institution's classifications.  If an institution does not
agree with an examiner's classification of an asset, it may appeal this
determination to the OTS Regional Director.

     The Bank regularly reviews its assets to determine whether assets require
classification or re-classification, and the Board of Directors reviews and
approves all classifications.  As of December 31, 1998, the Bank had no assets
classified as loss or as doubtful, $482,000 of assets classified as substandard
and no assets designated as special mention.  The Bank's total adversely
classified assets represented approximately 0.5% of its total assets and 4.2% of
its tangible regulatory capital at December 31, 1998.  At that date,
substantially all of its adversely classified or designated assets were one- to
four-family residences in its primary market area, and none of such assets was
in excess of $50,000.  At December 31, 1998, the Bank did not expect to incur
any loss in excess of attributable existing reserves on any of its adversely
classified or designated assets.

     In extending credit, the Bank recognizes that losses will occur and that
the risk of loss will vary with, among other things, the type of credit being
extended, the creditworthiness of the obligor over the term of the obligation,
general economic conditions and, in the case of a secured obligation, the
quality of the security.  It is the Bank's policy to maintain allowances for
losses based on its assessment of the loan portfolio.  The Bank increase the
allowance for losses by charging provisions for losses against its income.

     The Bank's methodology for establishing the allowance for losses takes into
consideration probable losses that have been identified in connection with
specific assets as well as losses that have not been identified but can be
expected to occur.  The Bank conducts regular reviews of its assets and
evaluates the need to establish allowances on the basis of this review.
Allowances are established on a regular basis based on an assessment of risk in
assets taking into consideration the composition and quality of the portfolio,
delinquency trends, current charge-off and loss experience, the state of the
real estate market, regulatory reviews conducted in the regulatory examination
process, general economic conditions and other factors deemed relevant by the
Bank.  Allowances are provided for individual assets, or portions of assets,
when ultimate collection is considered improbable based on the current payment
status of the assets and the fair value or net realizable value of the
collateral.  At the date of foreclosure or other repossession or at the date a
property is determined to be an "in-substance foreclosed" property, the Bank
transfers the property to real estate acquired in settlement of loans at the
lower of cost or fair value.  Fair value is defined as the amount in cash or
cash-equivalent value of other consideration that a property would yield in a
current sale between a willing buyer and a willing seller.  Fair value is
measured by market transactions.  If a market does not exist, fair value of the
property is estimated based on selling prices of similar properties in active
markets or, if there are no active markets for similar properties, by
discounting a forecast of expected cash flows at a rate commensurate with the
risk involved.  Fair value generally 

                                       10
<PAGE>
 
is determined through an appraisal at the time of foreclosure. At December 31,
1998, the Bank held no properties acquired in settlement of loans for which
market values were unavailable. Any amount of cost in excess of fair value is
charged-off against the allowance for loan losses. The Bank records an allowance
for estimated selling costs of the property immediately after foreclosure.
Subsequent to acquisition, the property is periodically evaluated, and an
allowance is established if the estimated fair value of the property, less
estimated costs to sell, declines. If, upon ultimate disposition of the
property, net sales proceeds exceed the net carrying value of the property, a
gain on sale of real estate is recorded.

     The banking regulatory agencies, including the OTS, have adopted a policy
statement about maintenance of an 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 the Bank's policy on
allocating these allowances to determine whether it is reasonable based on all
relevant factors.

     The Bank actively monitors its asset quality and charges off loans and
properties acquired in settlement of loans against the allowances for losses on
such loans and such properties when appropriate and provide specific loss
allowances when necessary.  Although the Bank believes it uses the best
information available to make determinations with respect to the allowances for
losses, future adjustments may be necessary if economic conditions differ
substantially from the economic conditions in the assumptions used in making the
initial determinations.

     The following table sets forth information about activity in the Bank's
allowance for loan losses for the periods indicated.
<TABLE>
<CAPTION>
                                        Year Ended December 31,
                                        -----------------------
                                          1998    1997    1996
                                         ------  ------  ------  
                                         (Dollars in thousands)
<S>                                      <C>     <C>     <C>
 
Balance at beginning of period........     $628   $ 494   $ 496
Charge-offs:                             
  Consumer............................      (15)    (18)     (4)
Recoveries:                              
  Consumer............................        4       2       2
                                          -----   -----   -----
Net charge-offs.......................      (11)    (16)     (2)
Provision for loan losses.............       24     150      --
                                          -----   -----   -----
Balance at end of period..............    $ 641   $ 628   $ 494
                                          =====   =====   =====
Ratio of net charge-offs to average      
 loans outstanding during the period..     0.02%   0.03%   0.01%
                                          =====   =====   =====
 
</TABLE>

                                       11
<PAGE>
 
     The following table sets forth information about the Bank's allowance for
loan losses by asset 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 December 31,
                                           -------------------------------------------------------------------
                                                    1998                    1997                 1996
                                           ----------------------  ---------------------  --------------------
                                                     Percent of             Percent of            Percent of
                                                    Loans in Each          Loans in Each         Loans in Each
                                                     Category to            Category to           Category to
                                            Amount  Total Loans    Amount   Total Loans   Amount  Total Loans 
                                           -------  -------------  ------  -------------  ------  ------------
                                                                   (Dollars in thousands) 
<S>                                        <C>      <C>            <C>     <C>            <C>     <C>
Real estate loans:
  One- to four-family residential....         $375       76.1%       $400       82.0%       $300      86.6%
  Commercial.........................           78       13.2          40        7.1          23       5.0
  Construction.......................           37        5.9          38        6.6          39       4.1
Consumer loans.......................          151        4.8         150        4.3         132       4.3
                                              ----      -----        ----      -----        ----     -----
    Total allowance for loan losses..         $641      100.0%       $628      100.0%       $494     100.0%
                                              ====      =====        ====      =====        ====     =====
 
</TABLE>

     During periods of recession or other economic distress, numerous financial
institutions throughout the United States have incurred substantial losses due
to significant increases in loss provisions and charge-offs resulting largely
from higher levels of loan delinquencies and foreclosures.  As a result of
losses experienced by many financial institutions during these periods, there
has been a greater level of scrutiny by regulatory authorities of the loan
portfolios of financial institutions undertaken as part of examinations of such
institutions by the FDIC, OTS or other federal or state regulators.  While the
Bank believes it has established its existing loss allowances in accordance with
generally accepted accounting principles, there can be no guarantee or assurance
that such reserves are, or in the future will be, adequate to absorb all loan
losses or that regulators, in reviewing its assets, will not make the Bank
increase its loss allowance, thereby negatively affecting its reported financial
condition and results of operations.

                                       12
<PAGE>
 
     The following table sets forth information about the Bank's nonperforming
assets at the dates indicated. At these dates, the Bank did not have any assets
accounted for on a nonaccrual basis or modified in a troubled debt
restructuring. For information about the Bank's interest accrual practices, see
Note 3 of the Notes to Consolidated Financial Statements.

<TABLE>
<CAPTION>
 
                                                                                 At December 31,
                                                                              ----------------------
                                                                               1998    1997    1996
                                                                              ------  ------  ------
                                                                              (Dollars in thousands)
<S>                                                                           <S>     <C>     <C>
 
Accruing loans which are contractually past due 90 days or more:
 Real estate loans:
  One- to four-family residential.................................            $ 407   $ 638   $ 375
  Commercial......................................................               --      --      --
  Construction....................................................               --      --      --
 Consumer loans...................................................               31      17       5
                                                                              -----   -----   -----
  Total non performing loans......................................            $ 438   $ 655   $ 380
                                                                              =====   =====   =====
 
Percentage of total loans.........................................             0.88%   1.36%   0.84%
                                                                              =====   =====   =====
 
Other nonperforming assets/1/.....................................            $  --   $  19   $  --
                                                                              =====   =====   =====
 
Total nonperforming assets........................................            $ 438   $ 674   $ 380
                                                                              =====   =====   =====
 
Percentage of total assets........................................             0.50%   0.75%   0.84%
                                                                              =====   =====   =====
</TABLE> 
-------------------------
/1/  Other nonperforming assets includes property acquired through foreclosure
     or repossession.  This property is carried at the lower of its fair value
     less estimated selling costs or the principal balance of the related loan,
     whichever is lower.


     At December 31, 1998, the Bank had identified approximately $44,000 of
loans which amount is not reflected in the preceding table but as to which known
information about possible credit problems of borrowers caused the Bank to have
doubts as to the ability of the borrowers to comply with present loan repayment
terms, all of which was included in the Bank's adversely classified or
designated asset amounts at that date.  At that date, the Bank did not expect to
incur any loss in excess of attributable existing reserves on any of its assets.

Investment Activities

     The Bank is permitted under federal law to make certain investments,
including investments in securities issued by various federal agencies and state
and municipal governments, deposits at the Federal Home Loan Bank of Cincinnati,
certificates of deposit in federally insured institutions, certain bankers'
acceptances and federal funds.  The Bank may also invest, subject to certain
limitations, in commercial paper rated in one of the two highest investment
rating categories of a nationally recognized credit rating agency, and certain
other types of corporate debt securities and mutual funds.  Federal regulations
require the Bank to maintain an investment in Federal Home Loan Bank stock and a
minimum amount of liquid assets which may be invested in cash and specified

                                       13
<PAGE>
 
securities.  From time to time, the OTS adjusts the percentage of liquid assets
which savings institutions are required to maintain.  See " -- Regulation of the
Bank -- Liquidity Requirements."

     The Bank makes investments in order to maintain the levels of liquid assets
required by regulatory authorities and manage cash flow, diversify its assets,
obtain yield and, under prior federal income tax law, satisfy certain
requirements for favorable tax treatment.  These investment activities consist
of investments in mortgage-backed securities and other investment securities,
primarily securities issued or guaranteed by the U.S. government or agencies
thereof and securities issued by municipalities and other governmental
authorities.  Investment and aggregate investment limitations and credit quality
parameters of each class of investment are prescribed in the investment policy
of the Bank.  Securities purchases are authorized by the investment committee of
the Bank's Board of Directors and ratified by the Bank's Board of Directors.

     Securities designated as "held to maturity" are those assets which the Bank
has the ability and intent to hold to maturity.  The held to maturity investment
portfolio is carried at amortized cost.  Securities designated as "available for
sale" are those assets which the Bank might not hold to maturity and thus are
carried at market value with unrealized gains or losses, net of tax effect,
recognized in equity.

     Mortgage-backed securities typically represent an interest in a pool of
fixed-rate or adjustable-rate  mortgage loans, the principal and interest
payments on which are passed from the mortgage borrowers to investors such as
the Bank.  Mortgage-backed security sponsors may be private companies or quasi-
governmental agencies such as the FHLMC, FNMA and GNMA, which guarantee the
payment of principal and interest to investors.  Mortgage-backed securities can
represent a proportionate participation interest in a pool of loans or,
alternatively, an obligation to repay a specified amount secured by a pool of
loans (commonly referred to as a "collateralized mortgage obligation," or
"CMO").  Mortgage-backed securities generally increase the quality of the Bank's
assets by virtue of the credit enhancements that back them, are more liquid than
individual mortgage loans and may be used to collateralize borrowings or other
obligations.  The Bank's mortgage-backed securities portfolio primarily consists
of seasoned securities issued by one of the quasi-governmental agencies.

     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 

                                       14
<PAGE>
 
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 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. Prepayment experience is
more difficult to estimate for adjustable-rate mortgage-backed securities.

     All of the Bank's securities issued by municipalities or comparable
governmental authorities were rated "A" or higher by a nationally recognized
credit rating agency at the time of purchase.  The Bank regularly monitors the
ratings of these holdings by reference to nationally published rating media and
by communication with the issuer where necessary.  As of December 31, 1998, none
of these securities had been downgraded from its original rating, and these
issues were primarily obligations of Tennessee municipalities.  At December 31,
1998, these securities had a weighted average coupon of 5.2% and a weighted
average term to maturity of approximately 42 months.  The carrying value of
these securities was $1.4 million, or 4.3% of the investment securities of the
Bank at that date.  None of its privately issued securities is insured or
guaranteed by FHLMC or FNMA.

     The following table sets forth information about carrying values of the
Bank's investment securities at the dates indicated.
<TABLE>
<CAPTION>
 
                                                        At December 31,
                                                  -------------------------
                                                    1998     1997     1996
                                                  -------  -------  -------
                                                        (In thousands)
<S>                                               <C>      <C>      <C>

Securities available for sale:
 Mortgage-backed securities.............          $24,066  $ 9,439  $ 7,400
 U.S. government and agency securities..            4,548    4,026    2,989
 FHLMC preferred stock..................            1,806    1,176      774
 FHLB stock.............................              589      548      511
 Other..................................               15       15       15
 
Securities held to maturity:
 Obligations of states and political
   subdivisions.........................            1,402    1,077    1,212
 Mortgage-backed securities.............               --       --       --
                                                  -------  -------  -------
  Total.................................          $32,426  $16,281  $12,901
                                                  =======  =======  =======
</TABLE>

                                       15
<PAGE>
 
     The following schedule analyzes the Bank's investment portfolio at December
31, 1998 by time remaining to maturity and presents the average yield for each
range of maturities.
<TABLE>
<CAPTION>
 
                                Less than            One to             Five to           More than      
                                 One Year          Five Years          Ten Years          Ten Years      Total Investment Portfolio 
                            ------------------  -----------------  -----------------  -----------------  --------------------------
                            Carrying  Average   Carrying  Average  Carrying  Average  Carrying  Average  Carrying  Market   Average
                             Value     Yield     Value     Yield    Value     Yield    Value     Yield    Value     Value    Yield
                            --------  --------  --------  -------  --------  -------  --------  -------  --------  -------  -------
                                                                      (Dollars in thousands)
<S>                         <C>       <C>       <C>       <C>      <C>       <C>      <C>       <C>      <C>       <C>      <C>
 
Securities available for
 sale:
  Mortgage-backed
   securities............     $  690       6.4%   $3,450      6.0%   $1,933      6.5%  $17,993      5.9%  $24,066  $24,066      5.9%
  U.S. government and
   agency securities.....        501       5.9     3,050      6.1       997      5.9        --       --     4,548    4,548      6.0
  FHLMC preferred stock..         --        --        --       --        --       --     1,806     49.0     1,806    1,806     49.0
  FHLB stock.............         --        --        --       --        --       --       589      7.0       589      589      7.0
  Other..................         --        --        --       --        --       --        15       --        15       15       --
 
Securities held to
 maturity:
  Obligations of states
   and political
   subdivisions..........         --        --       678      4.8       724      5.5        --       --     1,402    1,423      5.2
                            --------            --------           --------           --------            -------  -------
 
     Total...............     $1,191              $7,178             $3,653            $20,403            $32,426  $32,447
                            ========            ========           ========           ========            =======  =======
</TABLE> 

                                       16
<PAGE>
 
Deposit Activity and Other Sources of Funds

     General.  Deposits are the primary source of funds for lending, investment
activities and general operational purposes.  In addition to deposits, the Bank
derives funds from loan principal and interest repayments, maturities of
investment securities and mortgage-backed 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.  The Bank has access to borrow advances
from the Federal Home Loan Bank of Cincinnati, which it uses from time to time.

     Deposits.  The Bank attracts deposits principally from within its primary
market area by offering competitive rates on its deposit instruments, including
money market accounts, negotiable order of withdrawal ("NOW") accounts, passbook
deposit accounts, individual retirement accounts ("IRAs"), and certificates of
deposit which range in maturity from 90 days to three 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 deposit accounts are established on a periodic basis.
In determining the characteristics of deposit accounts, the Bank considers the
rates offered by competing institutions, lending and liquidity requirements,
growth goals and federal regulations.  The Bank does not accept brokered
deposits or pay negotiated rates for jumbo deposits.

     The Bank attempts to compete for deposits with other financial institutions
in its market area by offering competitively priced deposit instruments that are
tailored to the needs of its customers.  Additionally, the Bank seeks to meet
customers' needs by providing convenient customer service to the community,
efficient staff and convenient hours of service.  Substantially all of the
Bank's depositors are local residents who reside in its primary market area.

                                       17
<PAGE>
 
     The Bank's savings deposits at December 31, 1998 were represented by the
various types of savings programs listed below.

<TABLE> 
<CAPTION> 

Weighted
Average
Interest          Minimum                                       Minimum                Percentage of
  Rate             Term                Category                 Balance     Balance    Total Savings 
--------    -----------------    -------------------------     ---------    -------    -------------
                                                                         (In thousands)      
<S>         <C>                  <C>                           <C>          <C>        <C>
2.02 %      None                 NOW accounts                  $      --    $ 6,865             9.83%
3.29        None                 Money market                      2,500      3,644             5.21
3.30        None                 Savings deposits-passbook            --     10,606            15.20
                                                                            -------           ------
                                                                                      
                                 Certificates of Deposit                              
                                 -----------------------                              
                                                                                      
4.52        91 days              Fixed-term, fixed-rate            2,500      5,895             8.44
4.53        6 months-Regular     Fixed-term, fixed-rate            2,500     10,029            14.36
4.59        6 months-IRA         Fixed-term, fixed-rate              100      3,040             4.35
4.66        12 months            Fixed-term, fixed-rate            1,000      8,759            12.54
4.66        18 months-Regular    Fixed-term, fixed-rate            1,000      3,020             4.32
4.85        18 months-IRA        Fixed-term, fixed-rate              100      2,376             3.40
4.79        30 months            Fixed-term, fixed-rate            1,000      2,283             3.27
4.79        Jumbos               Fixed-term, fixed-rate          100,000     13,318            19.08
                                                                            -------           ------
                                 Total certificates of deposit               48,720            69.76
                                                                            -------           ------
                                   Total deposits                           $69,835           100.00%
                                                                            =======           ======
</TABLE>

     The following tables set forth information about the Bank's average deposit
balances and rates during the periods presented.
<TABLE>
<CAPTION>
 
                                                Year Ended December 31,
                                -------------------------------------------------------
                                      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>
 
Escrow Accounts for Stock
 Subscriptions................  $ 1,968    3.0%    $ 1,282    3.0%    $    --      --%
NOW accounts..................    4,522    2.2       3,782    2.5       3,086     2.5
Money market deposits.........    2,382    3.3       2,098    3.3       2,176     3.3
Savings deposits -- passbook..    9,588    3.3      10,290    3.3       9,776     3.3
Certificates of deposit.......   39,816    4.6      40,412    5.4      36,044     5.3
                                -------            -------            -------
  Total.......................  $58,276            $57,864            $51,082
                                =======            =======            =======
 
</TABLE>

                                       18
<PAGE>
 
     The following table sets forth information about changes in dollar amounts
of the Bank's deposits in various types of accounts between the dates indicated.
<TABLE>
<CAPTION>
 
                                                           Increase                               Increase
                                 Balance at               (Decrease)    Balance at               (Decrease)
                                December 31,     % of      from Dec.   December 31,     % of      from Dec.
                                   1998        Deposits    31, 1997       1997        Deposits    31, 1996
                                ------------   --------   ----------   ------------   --------   ---------- 
                                                      (Dollars in thousands)
<S>                             <C>            <C>         <C>          <C>            <C>         <C>  
Escrow accounts for stock
 subscriptions................       $    --       0.00%    $(23,598)       $23,598      28.89%     $23,598
NOW accounts..................         6,865       9.83        3,027          3,838       4.70          450
Money market deposit..........         3,644       5.21          905          2,739       3.35          465
Savings deposits -- passbook..        10,606      15.19         (285)        10,891      13.34        1,198
Certificates of deposit.......        35,402      50.70        7,932         27,470      33.64        1,049
Jumbo certificates............        13,318      19.07          184         13,134      16.08        1,143
                                     -------  ---------     --------        -------   --------      -------
                                     $69,835     100.00%    $(11,835)       $81,670     100.00%     $27,903
                                     =======  =========     ========        =======   ========      =======
</TABLE> 

     The following table sets forth information about the Bank's time deposits
classified by rates at the dates indicated.
<TABLE>
<CAPTION>
 
                          At December 31,
                     -------------------------
                       1998     1997     1996
                     -------  -------  -------
                             (In thousands)
<S>                  <C>      <C>      <C>
 
4.00 -  5.99%...     $47,604  $39,714  $37,298
6.00 -  7.99%...       1,116      890    1,114
                     -------  -------  -------
                     $48,720  $40,604  $38,412
                     =======  =======  =======
</TABLE>

     The following table sets forth information about amounts and maturities of
the Bank's time deposits at December 31, 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%......   $42,805     $4,344       $455  $    --  $47,604
 6.00 -  7.99%......       915        201         --       --    1,116
                       -------     ------  ---------  -------  -------
                       $43,720     $4,545       $455  $    --  $48,720
                       =======     =====   =========  =======  =======
</TABLE>

                                       19
<PAGE>
 
     The following table sets forth information about amounts of the Bank's
certificates of deposit of $100,000 or more by time remaining until maturity at
December 31, 1998.
<TABLE>
<CAPTION>
 
                              Certificates
Maturity Period                of Deposit
----------------------------  ------------
                             (In thousands)
<S>                           <C>  
Six months or less..........     $ 9,871
Over six through 12 months..       2,163
Over 12 months..............       1,284
                                 -------
 Total......................     $13,318
                                 =======
 
</TABLE>

     The following table sets forth information about the Bank's savings
activities for the periods indicated.
<TABLE>
<CAPTION>
 
                                                                 At December 31,
                                                           ----------------------------
                                                             1998       1997     1996
                                                           --------   --------  -------  
                                                                 (In thousands) 
<S>                                                        <C>        <C>      <C>
 
Deposits..........................................         $ 54,926   $90,103  $53,859
Withdrawals.......................................           84,223    64,911   50,446
                                                           --------   -------  -------
Net increase (decrease) before interest credited
 and branch purchase..............................          (29,297)   25,192    3,413
Deposits acquired in branch purchase..............           14,909        --       --
Interest credited.................................            2,553     2,711    2,400
                                                           --------   -------  -------
  Net increase (decrease) in savings deposits.....         $(11,835)  $27,903  $ 5,813
                                                           ========   =======  =======
 
</TABLE>

     Borrowings.  Savings deposits historically have been the primary source of
funds for the Bank's lending, investments and general operating activities.  The
Bank is authorized, however, to use advances from the Federal Home Loan Bank of
Cincinnati to supplement its supply of lendable funds and to meet deposit
withdrawal requirements.  The Federal Home Loan Bank  functions as a central
reserve bank providing credit for savings institutions and certain other member
financial institutions.  As a member of the Federal Home Loan Bank System, the
Bank is required to own stock in the Federal Home Loan Bank and is authorized to
apply for advances.  Advances are pursuant to several different programs, each
of which has its own interest rate and range of maturities.  Advances from the
Federal Home Loan Bank of Cincinnati are secured by the Bank's stock in the
Federal Home Loan Bank and first mortgage loans.

                                       20
<PAGE>
 
     The Bank has historically funded its lending and investment activities
through deposits.  During 1998, the Bank began using Federal Home Loan Bank
advances to supplement deposits.  The following sets forth selected information
regarding the Bank's short-term borrowings at the dates and for the periods
indicated.
<TABLE>
<CAPTION>
 
                                                 At of or For the Year
                                                   Ended December 31,
                                                 ----------------------
                                                  1998    1997    1996
                                                 ------  ------  ------
                                                 (Dollars in thousands)
<S>                                              <C>     <C>     <C>  
FHLB Advances:
 Amount outstanding at end of period..........   $5,689  $ --    $ --
 Weighted average rate paid...................     4.75%   --%     --%
 Maximum amount outstanding at any month end..   $6,000  $ --    $ --
 Approximate average amount outstanding.......   $1,181  $ --    $ --
 Approximate weighted average rate paid.......     4.75%   --%     --%
 
</TABLE>

Subsidiary Activities

    As a federally chartered savings institution, the Bank is permitted to
invest an amount equal to 2% of its assets in non-savings institution service
corporation subsidiaries, with an additional investment of 1% of assets where
such investment serves primarily community, inner-city and community development
purposes.  Under such limitations, as of December 31, 1998 the Bank was
authorized to invest up to approximately $2.8 million in the stock of or loans
to such subsidiaries, including the additional 1% investment for community
inner-city and community development purposes.  Institutions meeting their
applicable minimum regulatory capital requirements may invest up to 50% of their
regulatory capital in conforming first mortgage loans to such subsidiaries in
which they own 10% or more of the capital stock.  At December 31, 1998, the Bank
did not have any subsidiaries.

Regulation of the Bank

    General.  As a federally chartered and insured savings institution, the Bank
is subject to extensive regulation by the OTS and the FDIC.  The Bank's lending
activities and other investments must comply with various federal and state
statutory and regulatory requirements, and the OTS periodically examines the
Bank for compliance with various regulatory requirements.  The FDIC also has
authority to conduct periodic examinations.  The Bank must file reports with the
OTS describing its activities and its financial condition and it must obtain
approvals from regulatory authorities before entering into certain transactions
such as the conversion or mergers with other financial institutions.  The Bank
is also subject to certain reserve requirements promulgated by the Federal
Reserve Board.  The Bank's relationship with its depositors and borrowers is
also regulated to a great extent by federal and state law, especially in such
matters as the ownership of deposit accounts and the form and content of its
mortgage documents.  This supervision and regulation is primarily intended to
protect depositors.  The regulatory structure also gives the regulatory

                                       21
<PAGE>
 
authorities extensive discretion in connection with their supervisory and
enforcement activities and examination policies, including policies with respect
to the classification of assets and the establishment of loan loss reserves for
regulatory purposes.  Any change in regulations, whether by the OTS, the FDIC or
any other government agency, could have a material adverse impact on the
operations of the Bank.

     Insurance of Deposit Accounts.  The FDIC maintains two separate funds for
the insurance of deposits up to prescribed statutory limits.  The Bank Insurance
Fund ("BIF") insures the deposits of commercial banks and the Savings
Association Insurance Fund ("SAIF") insures the deposits of savings institutions
such as the Bank.  The FDIC is authorized to establish separate annual
assessment rates for deposit insurance for members of the BIF and the SAIF.  The
FDIC may increase assessment rates for either fund if necessary to restore the
fund's ratio of reserves to insured deposits to its target level within a
reasonable time and may decrease such assessment rates if such target level has
been met.  The FDIC has established a risk-based assessment system for both SAIF
and BIF members.  Under this system, assessments are set within a range, based
on the risk the institution poses to its deposit insurance fund.  This risk
level is determined based on the institution's capital level and the FDIC's
level of supervisory concern about the institution.

     Because a significant portion of the assessments historically paid into the
SAIF by savings institutions were used to pay the cost of prior savings
institution failures, the reserves of the SAIF were below the level required by
law.  The BIF, however, met its required reserve level.  As a result, deposit
insurance premiums for deposits insured by the BIF were substantially less than
premiums for deposits such as the Bank's which are insured by the SAIF.  In
order to recapitalize the SAIF, savings institutions with deposits insured by
the SAIF were required to pay a special assessment equal to $0.657 per $100 of
SAIF-assessable deposits held at March 31, 1995.  The Bank recognized an expense
of $317,000 for this special assessment during fiscal 1996.  The special
assessment eliminated the significant premium disparity between the BIF and the
SAIF.

     Beginning January 1, 1997, the Bank's annual deposit insurance premium was
reduced from 0.23% to 0.0644% of total assessable deposits.  BIF institutions
still pay lower assessments than comparable SAIF institutions, because BIF
institutions pay only 20% of the rate paid by SAIF institutions on their
deposits with respect to obligations issued by a federally chartered corporation
which provided some of the financing required to resolve the thrift crisis in
the 1980s.

     The recapitalization legislation also provides for the merger of the SAIF
and BIF effective January 1, 1999, assuming there are no savings institutions
under federal law.  Under separate proposed legislation, Congress is considering
the elimination of the federal thrift charter and the separate federal
regulation of thrifts.  As a result, the Bank might have to convert to a
different financial institution charter and be regulated under federal law as a
national bank or under Tennessee law as a state chartered commercial bank,
including being subject to the more restrictive activity limitations imposed on
national banks.  At this time, the Bank cannot predict the impact of this
legislation on its business until legislation is enacted.

                                       22
<PAGE>
 
     Regulatory Capital Requirements.  OTS capital regulations require savings
institutions, such as the Bank, to meet three capital standards: (1) tangible
capital equal to at least 1.5 % of total adjusted assets, (2) Tier 1 or core
capital equal to at least 4.0 % of total adjusted assets (3.0% if the
institution is rated composite 1 under the OTS examination rating system), and
(3) total capital equal to at least 8.0 % of total risk-weighted assets.  In
addition, the OTS may require that a savings institution that has a risk-based
capital ratio less than 8.0%, a ratio of Tier 1 capital to risk-weighted assets
of less than 4.0% or a ratio of Tier 1 capital to adjusted total assets of less
than 4.0% (3.0% if the institution has received the highest rating on its most
recent examination) take certain actions to increase its capital ratios.   If
the institution's capital is significantly below the minimum required levels or
if it is unsuccessful in increasing its capital ratios, the OTS may
significantly restrict its activities.

    Tangible capital is defined as core capital less all intangible assets
(including supervisory goodwill), less certain mortgage servicing rights and
less certain investments.  Tier 1 or core capital is defined as common
stockholders' equity (including retained earnings), non-cumulative perpetual
preferred stock and minority interests in the equity accounts of consolidated
subsidiaries, certain non-withdrawable accounts and pledged deposits of mutual
savings institutions and qualifying supervisory goodwill, less non-qualifying
intangible assets, certain servicing rights and certain investments.

     Total capital equals the sum of core capital plus supplementary capital.
The components of supplementary capital include, among other items, cumulative
perpetual preferred stock, perpetual subordinated debt, mandatory convertible
subordinated debt, intermediate-term preferred stock, and the portion of the
allowance for loan losses not designated for specific loan losses.  Overall,
supplementary capital is limited to 100% of core capital.  The Bank must
calculate its risk-weighted assets by multiplying each asset and off-balance
sheet item by various risk factors as determined by the OTS, which range from 0%
for cash to 100% for delinquent loans, property acquired through foreclosure,
commercial loans, and other assets.

     At December 31, 1998, the Bank substantially exceeded all regulatory
capital requirements.

     Dividend and Other Capital Distribution Limitations.  Except in limited
circumstances, the Bank is prohibited from paying a dividend or other capital
distribution if the Bank would be undercapitalized after the distribution.  In
addition, the Bank may not declare or pay a cash dividend on its capital stock
if the effect would be to reduce its regulatory capital below the amount
required for the liquidation account established at the time of the Conversion.

     Savings associations must submit notice to the OTS prior to making a
capital distribution (which includes dividends, stock repurchases and amounts
paid to stockholders in another institution in a cash merger) if (a) they would
not be well capitalized after the distribution, (b) the distribution would
result in the retirement of any of the association's common or preferred stock
or debt counted as its regulatory capital, or (c) the association is a
subsidiary of a holding company.  A savings association must make application to
the OTS to pay a capital distribution if (x) the association 

                                       23
<PAGE>
 
would not be adequately capitalized following the distribution, (y) the
association's total distributions for the calendar year exceed the association's
net income for the calendar year to date plus its net income (less
distributions) for the preceding two years, or (z) the distribution would
otherwise violate applicable law or regulation or an agreement with or condition
imposed by the OTS.

     Qualified Thrift Lender Test.  Savings institutions must meet a Qualified
Thrift Lender test.  The Bank must maintain at least 65% of its portfolio assets
(total assets less intangible assets, property it uses in conducting its
business and liquid assets in an amount not exceeding 20% of total assets) in
Qualified Thrift Investments to satisfy the test.  Qualified Thrift Investments
consist primarily of residential mortgage loans and mortgage-backed and other
securities related to domestic, residential real estate or manufactured housing.
The shares of stock the Bank owns in the Federal Home Loan Bank of Cincinnati
also qualify as Qualified Thrift Investments.  Subject to an aggregate limit of
20% of portfolio assets, the Bank may also count the following as Qualified
Thrift Investments: (i) 50% of the dollar amount of residential mortgage loans
originated for sale, (ii) investments in the capital stock or obligations of any
service corporation or operating subsidiary as long as such subsidiary derives
at least 80% of its revenues from domestic housing related activities, (iii)
200% of the dollar amount of loans and investments to purchase, construct or
develop "starter homes," subject to certain other restrictions, (iv) 200% of the
dollar amount of loans for the purchase, construction or development of domestic
residential housing or community centers in "credit needy" areas or loans for
small businesses located in such areas, (v) loans for the purchase, construction
or development of community centers, (vi) loans for personal, family, household
or educational purposes, subject to a maximum of 10% of portfolio assets, and
(vii) shares of FHLMC or FNMA stock.

     If the Bank satisfies the test, it will continue to enjoy full borrowing
privileges from the Federal Home Loan Bank of Cincinnati.  If the Bank does not
satisfy the test it may lose its borrowing restrictions and be subject to
activities and branching restrictions applicable to national banks.  Compliance
with the Qualified Thrift Lender test is determined on a monthly basis in nine
out of every 12 months.  As of December 31, 1998, the Bank was in compliance
with its Qualified Thrift Lender requirement with approximately 96% of its
assets invested in Qualified Thrift Investments.

     Transactions With Affiliates.  Generally, transactions between the Bank and
its affiliates are subject to certain limitations.  Such transactions must be on
terms as favorable to the Bank as comparable transactions with non-affiliates.
In addition, certain of these transactions are restricted to an aggregate
percentage of the Bank's capital.  Collateral in specified amounts must usually
be provided by affiliates in order to receive loans from the Bank.   The Bank's
affiliates include the Company and any company which would be under common
control with the Bank.  In addition, the Bank may not extend credit to any
affiliate engaged in activities not permissible for a bank holding company or
acquire the securities of any affiliate that is not a subsidiary.  The OTS has
the discretion to treat subsidiaries of savings institution as affiliates on a
case-by-case basis.

                                       24
<PAGE>
 
     Loans to Directors, Executive Officers and Principal Stockholders.  The
Bank cannot make loans in excess of certain levels to its directors, executive
officers or, after the conversion, 10% or greater stockholders (or any of their
affiliates) unless the loan is approved in advance by a majority of its Board of
Directors with any "interested" director not voting.  The Bank is also
prohibited from paying overdrafts of its directors or executive officers.  The
Bank is also subject to certain other restrictions on the amount and type of
loans to executive officers and directors and must annually report such loans to
its regulators.

     Limits on Loans to One Borrower.  The Bank generally is subject to the
lending limits applicable to national banks.  With certain limited exceptions,
loans and extensions of credit outstanding to a person at one time may not
exceed 15% of unimpaired capital and surplus of the Bank.  The Bank may lend an
additional amount, equal to 10% of unimpaired capital and surplus, if such loan
is fully secured by readily marketable collateral.  The Bank is additionally
authorized to make loans to one borrower, for any purpose, in an amount not to
exceed $500,000 or, by order of the Director of the OTS, in an amount not to
exceed the lesser of $30,000,000 or 30% of unimpaired capital and surplus to
develop residential housing, provided:  (i) the purchase price of each single-
family dwelling in the development does not exceed $500,000; (ii) the
institution is in compliance with its fully phased-in capital requirements;
(iii) the loans comply with applicable loan-to-value requirements, and; (iv) the
aggregate amount of loans made under this authority does not exceed 150% of
unimpaired capital and surplus.  The Bank is also authorized to make loans to
one borrower to finance the sale of real property acquired in satisfaction of
debts in an amount up to 50% of unimpaired capital and surplus.  Certain types
of loans are excepted from the lending limits.

     At December 31, 1998, the maximum amount that the Bank could have lent to
any one borrower under the 15% limit was approximately $2.1 million.  At such
date, the largest aggregate amount of loans that were outstanding to any one
borrower or group of affiliated borrowers was $1.5 million.

     Liquidity Requirements.  All savings institutions are required to maintain
an average daily balance of liquid assets equal to a certain percentage of the
sum of the Bank's average daily balance of net withdrawable deposit accounts
and, if any, borrowings payable in one year or less.  The liquidity requirement
may vary from time to time (between 4% and 10%) depending upon economic
conditions and savings flows of all savings institutions.  At December 31, 1998,
the Bank's required liquid asset ratio was 5% and its actual ratio was 15.5%.
Monetary penalties may be imposed upon institutions for violations of liquidity
requirements.

     Federal Home Loan Bank System.  The Bank is a member of the Federal Home
Loan Bank of Cincinnati, which is one of 12 regional Federal Home Loan Banks.
Each Federal Home Loan Bank serves as a reserve or central bank for its members
within its assigned region.  It is funded primarily from funds deposited by
savings institutions and proceeds derived from the sale of consolidated
obligations of the Federal Home Loan Bank System.  It makes loans to members
(that is, advances) in accordance with policies and procedures established by
the board of directors of the Federal Home Loan Bank.

                                       25
<PAGE>
 
     As a member, the Bank is required to purchase and maintain stock in the
Federal Home Loan Bank of Cincinnati in an amount equal to at least 1% of its
aggregate unpaid residential mortgage loans, home purchase contracts or similar
obligations at the beginning of each year, or 1/20 of its advances from the
Federal Home Loan Bank of Cincinnati, whichever is greater.  At December 31,
1998, the Bank had $589,000 in Federal Home Loan Bank stock, at cost, which was
in compliance with this requirement.  The Federal Home Loan Bank imposes various
limitations on advances such as limiting the amount of certain types of real
estate related collateral to a percentage of a member's capital and limiting
total advances to a member.  At December 31, 1998, the Bank had advances
outstanding of $5,689,000.

     Federal Reserve System.  The Federal Reserve Board requires all depository
institutions to maintain noninterest-bearing reserves at specified levels
against their transaction accounts (primarily checking, NOW and Super NOW
checking accounts) and non-personal time deposits.  The balances maintained to
meet the reserve requirements imposed by the Federal Reserve Board may be used
to satisfy the liquidity requirements that are imposed by the OTS.  At December
31, 1998, the Bank's reserve met the minimum level required by the Federal
Reserve System.

Regulation of the Company

     General.  The Company is registered as a savings and loan holding company
and files reports with the OTS and is subject to regulation and examination by
the OTS.  In addition, the OTS has enforcement authority over the Company and
any non-savings institution subsidiaries.  This permits the OTS to restrict or
prohibit activities that it determines to be a serious risk to the Bank.  This
regulation is intended primarily for the protection of the depositors and
deposit insurance fund of the Bank and not for the benefit of stockholders of
the Company.

     The Company is also required to file certain reports with, and comply with
the rules and regulations of, the Securities and Exchange Commission under the
federal securities laws.

    Activities Restrictions.  Since the Company will own only one savings
institution, it will be able to diversify its operations into activities not
related to banking, but only so long as the Bank satisfies the Qualified Thrift
Lender  test.  If the Company controls more than one savings institution, it
would lose the ability to diversify its operations into non-banking related
activities, unless such other savings institutions each also qualify as a
Qualified Thrift Lender and were acquired in a supervised acquisition.  See " --
Regulation of the Bank -- Qualified Thrift Lender Test."

     Restrictions on Acquisitions.  The Company must obtain approval from the
OTS before acquiring control of any other savings institution or savings and
loan holding company, substantially all the assets thereof or in excess of 5% of
the outstanding shares of another savings institution or savings and loan
holding company.  The Company's directors and officers or persons owning or
controlling more than 25% of the Company's stock, must also obtain approval of
the OTS before acquiring control of any savings institution or savings and loan
holding company.

                                       26
<PAGE>
 
     The OTS may approve acquisitions that will result in the formation of a
multiple savings and loan holding company which controls savings institutions in
more than one state only if:  (i) the multiple savings and loan holding company
involved controls a savings institution which operated a home or branch office
in the state of the institution to be acquired as of March 5, 1987; (ii) the
acquiror is authorized to acquire control of the savings institution pursuant to
the emergency acquisition provisions of the Federal Deposit Insurance Act; or
(iii) the statutes of the state in which the institution to be acquired is
located specifically permit institutions to be acquired by state-chartered
institutions or savings and loan holding companies located in the state where
the acquiring entity is located (or by a holding company that controls such
state-chartered savings institutions).

Taxation

     Federal Taxation. The Bank is 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.  However, prior to August 1996, savings
institutions such as the Bank, which met certain definitional tests and other
conditions prescribed by the Internal Revenue Code could benefit from certain
favorable provisions regarding their deductions from taxable income for annual
additions to their bad debt reserve.  The amount of the bad debt deduction that
a qualifying savings institution could claim for tax purposes with respect to
additions to its reserve for bad debts for "qualifying real property loans"
could be based upon its actual loss experience (the "experience method" or as a
percentage of its taxable income (the "percentage of taxable income method").
Historically, the Bank used the method that would allow it to take the largest
deduction.

     In August 1996, the Internal Revenue Code was revised to equalize the
taxation of savings institutions and banks.  Savings institutions, such as the
Bank, no longer have a choice between the percentage of taxable income method
and the experience method in determining additions to bad debt reserves.
Thrifts with $500 million of assets or less may still use the experience method,
which is generally available to small banks currently.  Larger thrifts may only
take a tax deduction when a loan is actually charged off.  Any reserve amounts
added after 1987 will be taxed over a six year period beginning in 1996;
however, bad debt reserves set aside through 1987 are generally not taxed.  A
savings institution may delay recapturing into income its post-1987 bad debt
reserves for an additional two years if it meets a residential-lending test.
This law is not expected to have a material impact on the Bank.  At December 31,
1998, the Bank had approximately $283,000 of post-1987 bad debt reserves.

     Earnings appropriated to the Bank's bad debt reserve and claimed as a tax
deduction including its supplemental reserves for losses will not be available
for the payment of cash dividends or for distribution (including distributions
made on dissolution or liquidation), unless the Bank includes the amount in
income, along with the amount deemed necessary to pay the resulting federal
income tax.  If such amount is used for any purpose other than bad debt losses,
including a dividend distribution or a distribution in liquidation, the Bank
will be subject to federal income tax at the then current rate.

    The Internal Revenue Code imposes a tax ("AMT") on alternative minimum
taxable income ("AMTI") at a rate of 20%. AMTI is increased by certain
preference items, including the excess of the tax bad debt reserve deduction
using the percentage of taxable income method over the deduction 

                                       27
<PAGE>
 
that would have been allowable under the experience method. Only 90% of AMTI can
be offset by net operating loss carryovers of which the Bank currently has none.
AMTI is also adjusted by determining the tax treatment of certain items in a
manner that negates the deferral of income resulting from the regular tax
treatment of those items. Thus, the Bank's AMTI is increased by an amount equal
to 75% of the amount by which its adjusted current earnings exceeds its AMTI
(determined without regard to this adjustment and prior to reduction for net
operating losses). In addition, for taxable years beginning after December 31,
1986 and before January 1, 1996, an environmental tax of 0.12% of the excess of
AMTI (with certain modifications) over $2 million is imposed on corporations,
including us, whether or not an AMT is paid.

     The Company may exclude from its income 100% of dividends received from the
Bank as a member of the same affiliated group of corporations.  A 70% dividends
received deduction generally applies with respect to dividends received from
corporations that are not members of such affiliated group, except that an 80%
dividends received deduction applies if the Company owns more than 20% of the
stock of a corporation paying a dividend.  The above exclusion amounts, with the
exception of the affiliated group figure, were reduced in years in which the
Bank used the percentage of taxable income bad debt deduction method.

     The Bank's federal income tax returns have not been audited by the Internal
Revenue Service since 1992.

     State Taxation.  In addition to the Bank's federal income tax liability,
the State of Tennessee imposes an excise tax on savings institutions and other
corporations at the rate of 6% of net taxable income, which is computed based on
federal taxable income subject to certain adjustments.  The State of Tennessee
also imposes franchise and privilege taxes on savings institutions and other
corporations which, in the Bank's case, have not constituted significant expense
items.

Executive Officers Who Are Not Directors

     The following table sets forth information regarding the executive officers
of the Bank who do not serve on the Board of Directors.
<TABLE>
<CAPTION>
 
                           Age at
                         December 31,
     Name                   1998                  Title
----------------------   ------------   ---------------------------------------
<S>                      <C>            <C>  
Nancy L. Bryant              55         Vice President and Treasurer
 
Peggy Holston                49         Branch Manager and Assistant Secretary
 
</TABLE>

    Nancy L. Bryant serves as Vice President and Treasurer of the Bank and the
Company.  Ms. Bryant joined the Bank in 1966.  She is a member of the Newport
Business Women's Club, serves 

                                       28
<PAGE>
 
as a Director and Treasurer of Habitat for Humanity and received the 1993
Citizen of the Year Award from the Newport Chamber of Commerce.

    Peggy Holston has been employed with the Bank since 1971 and serves as its
Assistant Secretary and Branch Manager.  She has served on the Board of
Directors of the Newport/Cocke County Chamber of Commerce and is a member of the
Newport Business Women's Club.

Employees

    As of December 31, 1998, the Bank had 22 full-time employees and 1 part-time
employees, none of whom was represented by a collective bargaining agreement.
The Bank consider its relationships with its employees to be good.

Item 2.  Description of Property
--------------------------------

    The following table sets forth information about the offices of the Bank at
December 31, 1998.

<TABLE>
<CAPTION>
 
                         Year   Owned or               Approximate
                        Opened   Leased   Book Value  Square Footage  Deposits
                        ------  --------  ----------  --------------  --------
                                                                  (In thousands)
<S>                     <C>     <C>       <C>         <C>             <C>
Main Office:
  344 W. Broadway
  Newport, Tennessee      1973   Owned      $ 63,965       8,000       $37,665
 
Branch Offices:
  263 E. Broadway
  Newport, Tennessee      1960   Owned           175       5,400        17,330
 
  345 Cosby Highway
  Newport, Tennessee      1998   Owned       146,087       2,400        14,840
</TABLE>

     The book value of the Bank's aggregate investment in properties, premises
and equipment totaled approximately $474,000 at December 31, 1998.  See Note 4
of the Notes to Consolidated Financial Statements.


Item 3.  Legal Proceedings
--------------------------

     From time to time, the Bank is a party to various legal proceedings
incident to its business.  At December 31, 1998, there were no legal proceedings
to which the Bank was a party, or to which any of its property was subject,
which it expected to result in a material loss, and there were no pending
regulatory proceedings to which the Bank was a party, or to which any of its
properties was subject, which it expected to result in a material loss.

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

     No matters were submitted to a vote of security holders during the fourth
quarter of fiscal 1998.

                                       29
<PAGE>
 
                                 PART II


Item 5.  Market for Common Equity and Related Stockholder Matters
-----------------------------------------------------------------

The information set forth under the section titled "Market for Common Stock and
Related Stockholder Matters" in the Annual Report is filed as an exhibit to this
report and incorporated herein by reference.


Item 6.  Management's Discussion and Analysis or Plan of Operation
------------------------------------------------------------------

     The information set forth under the section titled "Management's Discussion
and Analysis of Financial Condition and Results of Operations" in the Annual
Report is filed as an exhibit to this report and incorporated herein by
reference.


Item 7.  Financial Statements
-----------------------------

     The Independent Auditor's Report and related financial statements and notes
in the Annual Report are filed as an exhibit to this report and incorporated
herein by reference.


Item 8.  Changes in and Disagreements with Accountants on Accounting and
------------------------------------------------------------------------
Financial Disclosure
--------------------

     Not applicable.


                                 PART III

Item 9.  Directors, Executive Officers, Promoters and Control Persons;
----------------------------------------------------------------------
Compliance with Section 16(a) of the Exchange Act
-------------------------------------------------

     Information concerning the directors and executive officers of the Company
is incorporated herein by reference to the sections titled "Item 1.  Business --
Executive Officers Who Are Not Directors" herein and "Election of Directors" and
"Voting Securities and Beneficial Ownership" in the Proxy Statement.

Item 10.  Executive Compensation
--------------------------------

     The information required by this item is incorporated herein by reference
to the section titled "Election of Directors -- Executive Compensation" in the
Proxy Statement.

                                       30
<PAGE>
 
Item 11.  Security Ownership of Certain Beneficial Owners and Management
------------------------------------------------------------------------

     The information required by this item is incorporated herein by reference
to the sections titled "Voting Securities and Beneficial Ownership" and
"Election of Directors" in the Proxy Statement.


Item 12.  Certain Relationships and Related Transactions
--------------------------------------------------------

     The information required by this item is incorporated herein by reference
to the section titled "Transactions with Management" in the Proxy Statement.


                                 PART IV

Item 13.  Exhibits List and Reports on Form 8-K
-----------------------------------------------

     (a) The following exhibits either are filed or otherwise furnished as part
of this report or are incorporated herein by reference:
<TABLE>
<CAPTION>
 
No.       Description
-----     -----------
<S>       <C>
*3.1      Charter of United Tennessee Bankshares, Inc.
      
*3.2      Bylaws of United Tennessee Bankshares, Inc.
      
*4        Form of Stock Certificate of United Tennessee Bankshares,
          Inc.
      
*10.1     Form of United Tennessee Bankshares, Inc. Stock Option
          and Incentive Plan +
      
*10.2     Form of United Tennessee Bankshares, Inc. Management
          Recognition Plan and Trust Agreement +

*10.3(a)  Employment Agreements between Newport Federal Savings
          and Loan Association and Richard G. Harwood, Nancy L. Bryant
          and Peggy Holston +

*10.3(b)  Guarantee Agreements  between United Tennessee
          Bankshares, Inc. and Richard G. Harwood, Nancy L. Bryant and
          Peggy Holston +

*10.4     Newport Federal Savings and Loan Association Long-Term
          Incentive Plan +
</TABLE> 

                                       31
<PAGE>
 
<TABLE> 
<S>       <C> 
*10.5     Newport Federal Savings and Loan Association Deferred
          Compensation Plan +

 13       1998 Annual Report to Stockholders
 
 21       Subsidiaries of the Registrant

 23       Consent of Pugh & Company, P.C.

 27       Financial Data Schedule
</TABLE> 
_______________
*    Incorporated by reference to the Company's Registration Statement on Form
     SB-2 (File No. 333-36465).
+    Management contract or compensatory plan or arrangement.


     (b) Reports on Form 8-K.  On December 14, 1998, the Company filed a Current
         -------------------                                                    
Report on Form 8-K reporting under Item 2 the completion of its acquisition of
the Newport, Tennessee Branch of Union Planters Bank of the Lakeway Area.  No
financial statements were filed with this report.

                                       32
<PAGE>
 
                                 SIGNATURES

     In accordance with Section 13 or 15(d) of the Exchange Act, the registrant
caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized.

                                   UNITED TENNESSEE BANKSHARES, INC.


Date:  March 25, 1999              By: /s/ Richard G. Harwood
                                   -----------------------------------
                                   Richard G. Harwood
                                   President and Chief Executive Officer
                                   (Duly Authorized Representative)


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


By: /s/ Richard G. Harwood            By: /s/ J. William Myers
    ----------------------                --------------------
    Richard G. Harwood                    J. William Myers
    President and Chief Executive         Chairman of the Board
     Officer   
    (Director and Principal 
     Executive, Financial 
     and Accounting Officer)

Date:   March 25, 1999                Date:  March 25, 1999


By: /s/ Tommy C. Bible                By: /s/ Clyde E. Driskill, Jr.
    ------------------                    --------------------------
    Tommy C. Bible                        Clyde E. Driskill, Jr.
    Director                              Director

Date:   March 25, 1999                Date:  March 25, 1999


By:  /s/ William B. Henry             By: /s/ Ben W. Hooper, III
     --------------------                 ----------------------
     William B. Henry                     Ben W. Hooper, III
     Director                             Director

Date:   March 25, 1999                Date:  March 25, 1999


By:  /s/ Robert L. Overholt           By: /s/ Robert D. Self
     ----------------------               ------------------
     Robert L. Overholt                   Robert D. Self
     Director                             Director

Date:   March 25, 1999                   Date:  March 25, 1999

                                       33