<PAGE>
 
                      SECURITIES AND EXCHANGE COMMISSION
                                        
                            Washington, D.C.  20549
                             ---------------------
                                   FORM 10-Q
              QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
                      THE SECURITIES EXCHANGE ACT OF 1934
 
   For the quarter ended: June 30, 1998   Commission file number:  33-42286
 
                      HENDERSON CITIZENS BANCSHARES, INC.
            (Exact name of registrant as specified in its charter)

     TEXAS                           6712                        75-2371232
-----------------              -----------------               --------------
(State or other                (Primary Standard               (IRS Employer
jurisdiction of                   Industrial                   Identification 
incorporation or                Classification                      No.)
organization)                    Code Number)          


                      201 WEST MAIN STREET, P.O. BOX 1009
                            HENDERSON, TEXAS 75653
                                (903) 657-8521
         (Address, including ZIP code, and telephone number, including
            area code, of registrant's principal executive offices)

                                        
 
     Securities registered pursuant to Section 12(b) of the Act:  None

     Securities registered pursuant to Section 12(g) of the Act:  None

Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.

                               X      Yes               No
                          -----------       -----------       
                                        

At June 30, 1998, 2,017,474 shares of Common Stock, $5.00 par value, were
outstanding.

                                       1
<PAGE>
 
Part I. FINANCIAL INFORMATION
Item 1. Financial Statements

             HENDERSON CITIZENS BANCSHARES, INC. AND SUBSIDIARIES

                          Consolidated Balance Sheets
                                  (unaudited)
                      June 30, 1998 and December 31, 1997
                 (dollars in thousands, except share amounts)

<TABLE>
<CAPTION>
                              Assets                                           1998                 1997
                             -------                                     --------------       --------------
<S>                                                                      <C>                  <C>
Cash and due from banks                                                  $        6,913                8,886
Interest-bearing deposits with
     other financial institutions                                                 4,976                8,212
Federal funds sold                                                                4,050                5,040
Securities:
   Held-to-maturity, approximate market value of $66,568
     in 1998 and $69,598 in 1997                                                 65,988               69,233
   Available-for-sale                                                           142,408              148,740
                                                                         --------------       --------------
                                                                                208,396              217,973
Loans, net                                                                      113,723              106,061
Premises and equipment, net                                                       5,369                5,209
Accrued interest receivable                                                       3,441                3,311
 
Other assets                                                                      3,221                3,801
                                                                         --------------       --------------
                                                                         $      350,089              358,493
                                                                         ==============       ==============
                Liabilities and Stockholders' Equity
                ------------------------------------
Deposits:
   Demand - noninterest-bearing                                                  37,642               32,860
   Interest-bearing transaction accounts                                         70,897               79,810
   Money market and savings                                                      44,922               46,206
   Certificates of deposit and other time deposits                              160,420              163,231
                                                                         --------------       --------------
                      Total deposits                                            313,881              322,107
Accrued interest payable                                                          1,083                1,105
Notes payable                                                                       444                  844
Other liabilities                                                                   445                1,708
                                                                         --------------       --------------
                                                                                315,853              325,764
Stockholders' equity:
   Preferred stock, $5 par value; 2,000,000 shares authorized
     none issued or outstanding                                                      --                   --
   Common stock, $5 par value; 10,000,000 shares authorized,
     2,160,000 issued                                                            10,800               10,800
   Surplus                                                                        5,400                5,400
   Retained earnings                                                             19,978               18,875
   Accumulated other comprehensive income                                            69                 (335)
                                                                         --------------       --------------
                                                                                 36,247               34,740
  Less treasury stock, 142,526 shares in 1998 and 142,506 shares                 (2,011)              (2,011)
        in 1997, at cost
                                                                         --------------       --------------
                        Total stockholders' equity                               34,236               32,729
Commitments and contingencies
                                                                         --------------       --------------
                                                                         $      350,089              358,493
                                                                         ==============       ==============
</TABLE>
See accompanying notes to consolidated financial statements.

                                       2
<PAGE>
 
             HENDERSON CITIZENS BANCSHARES, INC. AND SUBSIDIARIES
                       Consolidated Statements of Income
                                  (unaudited)
               (dollars in thousands, except per share amounts)


<TABLE>
<CAPTION>
                                                                           Three months                       Six months
                                                                          ended June 30,                    ended June 30,
                                                                -------------------------------   -------------------------------
                                                                     1998               1997           1998               1997
                                                                -------------     -------------   -------------     -------------
<S>                                                             <C>               <C>             <C>               <C>
Interest income:                                                                                 
   Loans                                                        $       2,382             2,129           4,658             4,224
   Securities                                                                                    
        Taxable - available-for-sale                                    2,129             2,336           4,327             4,530
        Taxable - held-to-maturity                                        463               592             998             1,326
        Tax-exempt                                                        387               462             743               899
   Federal funds sold                                                     111                33             191                86
   Interest-bearing deposits with other financial                         113                53             311               158
    institutions                                                                                 
                                                                -------------     -------------   -------------     -------------
          Total interest income                                         5,585             5,605          11,228            11,223
                                                                -------------     -------------   -------------     -------------
                                                                                                 
Interest expense:                                                                                
   Deposits:                                                                                     
        Transaction accounts                                              474               473             965               990
        Money market and savings                                          320               317             642               639
        Certificates of deposit and other time deposits                 2,084             2,112           4,190             4,192
   Other                                                                    8                13              15                26
                                                                -------------     -------------   -------------     -------------
          Total interest expense                                        2,886             2,915           5,812             5,847
                                                                -------------     -------------   -------------     -------------
                                                                                                 
          Net interest income                                           2,699             2,690           5,416             5,376
                                                                                                 
Provision for loan losses                                                 164                83             293               170
                                                                -------------     -------------   -------------     -------------
          Net interest income after provision for loan
           losses                                                       2,535             2,607           5,123             5,206
                                                                -------------     -------------   -------------     -------------
                                                                                                 
Other income:                                                                                    
        Gains (losses) on securities transactions, net                     40               (26)             66               (64)
        Income from fiduciary activities                                  200               150             405               288
        Service charges, commissions, and fees                            796               449           1,407               892
        Other                                                             139                83             287               158
                                                                -------------     -------------   -------------     -------------
          Total other income                                            1,175               656           2,165             1,274
                                                                -------------     -------------   -------------     -------------
                                                                                                 
Other expenses:                                                                                  
        Salaries and employee benefits                                  1,536             1,404           2,926             2,666
        Occupancy and equipment                                           330               253             638               486
        Regulatory assessments                                             30                34              64                60
        Other                                                             756               632           1,430             1,235
                                                                -------------     -------------   -------------     -------------
          Total other expenses                                          2,652             2,323           5,058             4,447
                                                                -------------     -------------   -------------     -------------
                                                                                                 
          Income before income taxes                                    1,058               940           2,230             2,033
                                                                                                 
Income tax expense                                                        217               204             482               462
                                                                -------------     -------------   -------------     -------------
               Net income                                       $         841               736           1,748             1,571
                                                                =============     =============   =============     =============
                                                                                                 
               Basic net income per common share                $        0.42              0.35            0.87              0.74
                                                                =============     =============   =============     =============
                                                                                                 
               Average number of shares outstanding                 2,017,478         2,121,640       2,017,486         2,125,946
                                                                =============     =============   =============     =============
</TABLE>

See accompanying notes to consolidated financial statements.

                                       3
<PAGE>
 
             HENDERSON CITIZENS BANCSHARES, INC. AND SUBSIDIARIES

                Consolidated Statements of Stockholders' Equity
                                  (unaudited)

                    Six months ended June 30, 1998 and 1997
               (dollars in thousands, except per share amounts)


<TABLE>
<CAPTION>
                                                                                      Accumulated
                                                                                         Other
                                                                                     Comprehensive
                                                                                        Income
                                                                                    --------------
                                                                                    Net Unrealized
                                                                                    Gains (Losses)
                                                                                     on Securities                  Total
                                      Preferred    Common               Retained       Available     Treasury   Stockholders'
                                        Stock      Stock     Surplus    Earnings       For Sale        Stock        Equity
                                    -----------   -------   --------   ---------   ---------------   --------   -------------
<S>                                 <C>           <C>       <C>        <C>         <C>               <C>        <C>
                                                                                                               
Balances at December 31, 1996       $        --    10,800      5,400      16,825              (703)      (334)         31,988
                                                                                                               
     Net income                              --        --         --       1,571                --         --           1,571
                                                                                                               
     Net change in unrealized                                                                                  
     losses on securities 
     available for sale                      --        --         --          --              (121)        --            (121)
                                                                                                          
                                                                                                               
     Cash dividends ($.32 per
     share)                                  --        --         --        (679)               --         --            (679)
                                                                                                               
     Purchase of 14,220 shares of
     treasury stock                          --        --         --          --                --       (172)           (172)
                                    -----------   -------   --------   ---------   ---------------   --------   -------------
                                                                                                               
Balances at June 30, 1997           $        --    10,800      5,400      17,717              (824)      (506)         32,587
                                    ===========   =======   ========   =========   ===============   ========   =============
                                                                                                               
Balances at December 31, 1997       $        --    10,800      5,400      18,875              (335)    (2,011)         32,729
                                                                                                               
     Net income                              --        --         --       1,748                --         --           1,748
                                                                                                               
     Net change in unrealized gains                                                                            
     on securities available for
     sale                                    --        --         --          --               404         --             404
                                                                                                               
     Cash dividends ($.32 per
     share)                                  --        --         --        (645)               --         --            (645) 
                                    -----------   -------   --------   ---------   ---------------   --------   -------------
                                                                                                               
Balances at June 30, 1998           $        --    10,800      5,400      19,978                69     (2,011)         34,236
                                    ===========   =======   ========   =========   ===============   ========   =============
</TABLE>

                                       4
<PAGE>
 
             HENDERSON CITIZENS BANCSHARES, INC. AND SUBSIDIARIES

                     Consolidated Statement of Cash Flows
                                  (unaudited)

                    Six months ended June 30, 1998 and 1997
                            (dollars in thousands)

<TABLE>
<CAPTION>
                                                                                            1998                 1997
                                                                                      --------------       --------------
<S>                                                                                   <C>                        <C>
Operating activities:
     Net income                                                                       $        1,748                1,571
     Adjustments to reconcile net income to net cash
        provided by operating activities:
               Net amortization of premium on securities                                         206                  190
               Net (gains) losses on securities transactions, net                                (66)                  64
               Provision for loan losses                                                         293                  170
               Depreciation and amortization                                                     500                  296
               (Increase) decrease in accrued interest receivable                               (130)                  46
               (Increase) decrease in other assets                                               407                 (775)
               Increase (decrease) in accrued interest payable                                   (22)                 442
               Decrease in other liabilities                                                  (1,149)                (374)
                                                                                      --------------       --------------
                    Net cash provided by operating activities                                  1,787                1,630
                                                                                      --------------       --------------
 
Investing activities:
     Proceeds from maturities and paydowns of held-to-maturity securities                     11,857               11,568
     Purchases of held-to-maturity securities                                                 (8,756)              (5,130)
     Proceeds from sales of available-for-sale securities                                     10,017               14,958
     Proceeds from maturities and paydowns of available-for-sale securities                   24,987                5,757
     Purchases of available-for-sale securities                                             ( 28,055)             (19,705)
     Net increase in loans                                                                    (7,955)              (1,490)
     Purchases of bank premises and equipment                                                   (487)              (1,247)
                                                                                      --------------       --------------
                    Net cash provided by investing activities                                  1,608                4,711
                                                                                      --------------       --------------
 
Financing activities:
     Net decrease in deposits                                                                 (8,226)              (7,650)
     Payment on notes payable                                                                   (400)                (667)
     Cash dividends paid                                                                        (968)                (679)
     Purchase of treasury stock                                                                   --                 (172)
                                                                                      --------------       --------------
                    Net cash used in financing activities                                     (9,594)              (9,168)
                                                                                      --------------       --------------
 
                    Decrease in cash and cash equivalents                                     (6,199)              (2,827)
Cash and cash equivalents at beginning of period                                              22,138               17,455
                                                                                      --------------       --------------
 
Cash and cash equivalents at end of period                                            $       15,939               14,628
                                                                                      ==============       ==============
 
Supplemental disclosures of cash flow activities:
Income taxes paid, net of refunds                                                     $          740                  590
                                                                                      ==============       ==============
 
Interest paid                                                                         $        5,834                5,405
                                                                                      ==============       ==============
</TABLE>

See accompanying notes to consolidated financial statements.

                                       5
<PAGE>
 
             HENDERSON CITIZENS BANCSHARES, INC. AND SUBSIDIARIES

                  Notes to Consolidated Financial Statements

                                 June 30, 1998
(1)  BASIS OF PRESENTATION
     ---------------------
 
     The accompanying consolidated financial statements are unaudited, but
       include all adjustments, consisting of normal recurring accruals, which
       management considers necessary for a fair presentation of the financial
       position, results of operations, and cash flows.

     Certain information and footnote disclosures normally included in financial
       statements prepared in accordance with generally accepted accounting
       principles have been condensed or omitted pursuant to Securities and
       Exchange Commission rules and regulations. The consolidated financial
       statements and footnotes included herein should be read in conjunction
       with the Company's annual consolidated financial statements as of
       December 31, 1997 and 1996, and for each of the years in the three year
       period ended December 31, 1997 included in the Company's Form 10-K.

(2)  SECURITIES
     ----------

     The amortized cost (carrying value) and approximate market values of
       securities held-to-maturity at June 30, 1998, are summarized as follows
       (in thousands of dollars):

<TABLE>
<CAPTION>
                                                                 Gross             Gross
                                             Amortized        Unrealized        Unrealized            Market
                                               Cost              Gains            Losses              Value
                                          -------------     -------------    --------------      --------------
<S>                                       <C>               <C>              <C>                 <C>
     U.S. Treasury                        $       7,026                23                (7)              7,042
                                     
     U.S. Government agencies                     6,102                15                --               6,117
                                     
     State and municipal                         36,560               582               (58)             37,084
                                     
     Mortgage-backed securities      
       and collateralized mortgage    
       obligations                               16,300                35               (20)             16,315
                                          -------------     -------------    --------------      --------------
                                          $      65,988               655               (85)             66,558
                                          -------------     -------------    --------------      --------------
</TABLE> 
 
     The amortized cost and approximate market values (carrying value) of
       securities available- for-sale at June 30, 1998, are summarized as
       follows (in thousands of dollars):
 
<TABLE> 
<CAPTION> 
                                                                 Gross            Gross
                                            Amortized         Unrealized       Unrealized             Market
                                               Cost              Gains            Losses              Value
                                          -------------     -------------    --------------      --------------
<S>                                       <C>               <C>              <C>                 <C>
     U.S. Treasury                        $      60,072               292                (9)             60,355
                                      
     U.S. Government agencies                    13,463                 9               (36)             13,436
                                      
     Mortgage-backed securities        
      and collateralized mortgage      
      obligations                                68,400               317              (468)             68,249
                                      
     Other                                          368                --                --                 368
                                          -------------     -------------    --------------      --------------
                                          $     142,303               618              (513)            142,408
                                          -------------     -------------    --------------      --------------
</TABLE>

                                       6
<PAGE>
 
             HENDERSON CITIZENS BANCSHARES, INC. AND SUBSIDIARIES

                  Notes to Consolidated Financial Statements

                                 June 30, 1998

(3)  LOANS AND ALLOWANCE FOR LOAN LOSSES
     -----------------------------------

     The composition of the Company's loan portfolio is as follows (in thousands
       of dollars):

<TABLE>
<CAPTION>
 
                                                                    June 30,             December 31,
                                                                      1998                   1997
                                                                --------------       -----------------
<S>                                                             <C>                  <C>
               Commercial and industrial                        $       30,029                  28,195
               Real estate mortgage                                     55,689                  49,979
               Installment and other                                    30,001                  29,832
                                                                --------------       -----------------
                         Total                                         115,719                 108,006
 
               Less:
                  Allowance for loan losses                             (1,513)                 (1,249)
                  Unearned discount                                       (483)                   (696)
                                                                --------------       -----------------
 
                         Loans, net                             $      113,723                 106,061
                                                                ==============       =================
</TABLE> 
 
 
     Changes in the allowance for loan losses for the six months ended June 30,
       1998 and 1997 are summarized as follows (in thousands of dollars):

<TABLE> 
<CAPTION> 
 
                                                                      1998                   1997
                                                                --------------       -----------------
<S>                                                             <C>                  <C>
               Balance, January 1                               $        1,249                   1,146
                  Provision charged to operating expense                   293                     170
                  Loans charged off                                       (126)                   (176)
                  Recoveries on loans                                       97                      56
                                                                --------------       -----------------
 
               Balance, June 30                                 $        1,513                   1,196
                                                                ==============       =================
</TABLE>


(4)  TOTAL COMPREHENSIVE INCOME
     --------------------------

     In June 1997, the Financial Accounting Standards Board issued Statement of
     Financial Accounting Standards (SFAS) No. 130, "Reporting Comprehensive
     Income". SFAS 130 requires that an entity include in total comprehensive
     income certain amounts that were previously recorded directly in
     stockholders' equity. For the six-month periods ended June 30, 1998 and
     1997, other comprehensive income amounts included in total comprehensive
     income consisted only of net unrealized gains (losses) on securities
     available for sale, net of income taxes. Total comprehensive income for the
     six-month periods ended June 30, 1998 and 1997, were $2,152,000 and
     $1,450,000, respectively.

                                       7
<PAGE>
 
Item 2.

        MANAGEMENT'S DISCUSSION AND ANALYSIS OF THE FINANCIAL CONDITION
       AND RESULTS OF OPERATIONS OF HENDERSON CITIZENS BANCSHARES, INC.
                FOR THE SIX MONTHS ENDED JUNE 30, 1998 AND 1997


The following discussion and analysis of the financial condition and results of
operations of the Company and its primary bank subsidiaries, Citizens National
Bank, Henderson, Texas, and First State Bank, Waskom, Texas, should be read in
conjunction with the consolidated financial statements and the notes thereto,
and other financial and statistical information appearing elsewhere in this
report.

Results of Operations
---------------------

Net income for the first six months of 1998 increased to $1,748,000 compared to
$1,571,000 for the same period in 1997.  The increase was primarily caused by an
increase in non-interest income. During the first six months of 1998, net
interest income increased slightly due to heightened loan demand although loan
and deposit interest rates generally remained unchanged. The Company made a
provision of $293,000 to the allowance for loan losses during the first six
months of 1998.  A provision of $170,000 was made for loan losses during the
same period in 1997. The Company experienced a gain on securities transactions
totaling approximately $66,000 in the first six months of 1998 compared to
losses of $64,000 in the first six months of 1997.  Other income, excluding
gains on securities transactions, for the first six months of 1998 was
$2,099,000 compared to $1,338,000 for the same period in 1997 due primarily to
an increase in insufficient funds fee income as a result of the initiation of a
new deposit program in March 1998 and the establishment of a trust office in
Corsicana, Texas in March 1997.  Total other expenses for the first six months
of 1998 were $5,058,000 compared to $4,447,000 for the same period in 1997.
Income tax expense for the first six months of 1998 and 1997 was $482,000 and
$462,000, respectively.

PROPOSED ACQUISITION
--------------------

In May 1998, the Company agreed to acquire certain assets and assume certain
liabilities of Jefferson National Bank, Jefferson, Texas, for a purchase price
of $6,500,000.  The acquisition of Jefferson National Bank will result in an
approximate increase in total assets of the Company of $32,977,000, total loans
of $7,779,000, and total deposits of $29,599,000, and will be accounted for
using the purchase method of accounting.

It is anticipated that the proposed acquisition will be completed, subject to
regulatory approvals, during the fourth quarter of 1998, although no assurance
can be given that the acquisition will be completed or that such timetable will
be met.  The acquisition is expected to be funded through internal sources.

MERGER OF FIRST STATE BANK WASKOM
---------------------------------

Citizens National Bank and First State Bank filed an application with the
Comptroller for approval to merge First State Bank with and into Citizens
National Bank under the charter and title of Citizens National Bank (the
"merger").  The sole banking office of First State Bank is now being operated as
a full-service branch of Citizens National Bank since completion of the merger
on July 23, 1998.  It is not anticipated that the merger will result in any
diminution of products and services currently available to customers of First
State Bank or Citizens National Bank.  It is anticipated, however, that the
merger will generate certain operational efficiencies by operating under one
bank charter rather than two separate charters regulated by different regulatory
authorities.

NET INTEREST INCOME
-------------------

For the six months ended June 30, 1998, net interest income was $5,416,000
compared to $5,376,000 for the first six months of 1997. The slight increase is
primarily the result of continued loan growth as loan and deposit interest rates
generally remained unchanged.

Net interest income for the three-month period ended June 30, 1998 was
$2,699,000 compared to $2,690,000 in 1997.  The increase in 1998 is the same as
the reasons noted above for the six-month period.

PROVISION FOR LOAN LOSSES
-------------------------

During the first six months of 1998, the Company increased its allowance for
loan losses through a provision of $293,000. The Company increased its allowance
for loan losses during the same period of 1997 by $170,000. The increase is
primarily due to an estimate for potential overdraft charge-offs that may result
from the insufficient funds fee program initiated in March 1998.

                                       8
<PAGE>
 
The Company experienced net charge-offs of $29,000 in the first six months of
1998 compared to net charge-offs of $120,000 in the same period in 1997.

For the three-month period ended June 30, 1998, the Company increased its
allowance through a provision of $164,000.  The Company increased its allowance
for loan losses during the same period in 1997 by $83,000.

See additional information related to the Company's loan operations in the
Allowance for Loan Loss section below.

OTHER INCOME AND EXPENSES
-------------------------

Non-interest income, excluding securities gains/losses, was $2,099,000 for the
first six months of 1998 as compared to $1,338,000 in the first six months of
1997. This increase is due to increases in service charges through the
initiation of an insufficient funds fee program in March 1998, as well as an
increase in trust revenues due to the establishment of a trust office in
Corsicana, Texas in March 1997. The Company experienced gains on securities
transactions for the first six months of 1998 of $66,000 compared to losses on
securities transactions for the first six months of 1997 of  $64,000. Other
expenses for the six-month period ended June 30, 1998 were $5,058,000 compared
to $4,447,000 during the same period in 1997. The increase in other expenses is
due to increases in general salaries and benefits, and occupancy and equipment
due to remodeling of the main bank facility in Henderson, Texas.

For the three months ended June 30, 1998, non-interest income, excluding
securities losses was $1,135,000 compared to $682,000 for the same period in
1997, with the majority of the increase due to insufficient funds fee income.
The Company experienced gains on securities transactions in the three months
ended June 30, 1998 of approximately $40,000 compared to losses on securities
transactions of $26,000 for the three months ended June 30, 1997.

INCOME TAXES
------------

Income tax expense for the first six months of 1998 was $482,000, compared to
$462,000 in the same period in 1997. The effective tax rate for the first six
months of 1998 and 1997, respectively, was 21.6% and 22.7%.  This effective rate
is less than the statutory rate primarily because of tax-free income provided
from state and municipal bonds, leases and obligations.  As these tax-free
investments, leases, and obligations mature and are replaced, the effective
income tax rate is expected to increase.

Income tax expense for the three-month periods ended June 30, 1998 and June 30,
1997 were $217,000 and $204,000 respectively.

FINANCIAL CONDITION
-------------------

The Company's total assets at June 30, 1998 of $350,089,000 decreased from the
total assets at December 31, 1997 of $358,493,000.  Total deposits were
$313,881,000 at June 30, 1998, compared to the December 31, 1997 total of
$322,107,000.

Equity capital of the Company, excluding unrealized gains or losses on
securities available for sale, as a percentage of total assets was 9.7% at June
30, 1998, compared to 9.2% at December 31, 1997.  The risk-based Tier I and Tier
II capital ratios and the leverage ratio of Citizens National Bank amounted to
24.4%, 25.6%, and 9.2%, respectively at June 30, 1998 compared to 23.7%, 24.7%,
and 9.1%, respectively, at December 31, 1997.  At June 30, 1998, First State
Bank had Tier I and Tier II capital ratios and a leverage ratio of 21.3%, 21.9%,
and 8.9%, respectively, compared to 27.5%, 28.0%, and 9.1%, respectively at
December 31, 1997.

LIQUIDITY AND CAPITAL RESOURCES
-------------------------------

At June 30, 1998, the Company's cash and cash equivalents of $15,939,000
decreased from the December 31, 1997 amount of $22,138,000.  The Company's
stockholders' equity of $34,236,000 remains at a level considered to be adequate
by management.  Profits in excess of dividends paid to shareholders are
reflected in the increase in undivided profits from 1997.

                                       9
<PAGE>
 
ALLOWANCE FOR LOAN LOSSES
-------------------------

The allowance for loan losses at June 30, 1998 and December 31,1997 was 1.31%
and 1.16% of outstanding loans, respectively. By its nature, the process through
which management determines the appropriate level of the allowance requires
considerable judgment.  The determination of the necessary allowance, and
correspondingly the provision for loan losses, involves assumptions about
projections of national and local economic conditions, the composition of the
loan portfolio, and prior loss experience, in addition to other considerations.
As a result, no assurance can be given that future losses will not vary from the
current estimates.  However, management believes that the allowance at June 30,
1998 is adequate to cover losses inherent in its loan portfolio.  A migration
analysis and an internal classification system for loans also helps identify
potential problems, if any, that are not identified otherwise.  From these
analyses, management determines which loans are potential candidates for
nonaccrual status, including impaired loan status, or charge-off.  Management
continually reviews loans and classifies them consistent with the Comptroller's
guidelines to help ensure that an adequate allowance is maintained.

The allocation of the allowance for loan losses is based upon the inherent risks
in the various components of the loan portfolio.  Amounts allocated to each
component are determined based on management's evaluations of concentrations of
credit risks, current and anticipated economic conditions, historical analyses,
and classification and estimated loss exposure assigned to specific credits.
These reserve allocations are subject to change as various economic conditions
dictate.  The following table is an analysis of the Allowance for Loan Losses.


                   ANALYSIS OF THE ALLOWANCE FOR LOAN LOSSES

<TABLE>
<CAPTION>
                                                                           For the Six Months Ended
                                                                                   June 30,
                                                                        1998                      1997
                                                                  ---------------           --------------
<S>                                                               <C>                       <C>
Balance at beginning of period                                    $         1,249                    1,146
Charge-offs:
          Commercial, financial, and agricultural                               7                       57
          Real estate-mortgage                                                 --                        1
          Installment loans to individuals                                    119                      118
                                                                  ---------------           --------------
                                                                              126                      176
Recoveries:
          Commercial, financial, and agricultural                              38                       32
          Installment loans to individuals                                     59                       24
                                                                  ---------------           --------------
                                                                               97                       56
                                                                  ---------------           --------------
 
Net charge-offs                                                                29                      120
                                                                  ---------------           --------------
Additions charged to operations                                               293                      170
                                                                  ---------------           --------------
Balance at end of period                                          $         1,513                    1,196
                                                                  ===============           ==============
Ratio of net charge-offs during
          the period to average loans outstanding
          during the period                                                    --                      .10%
                                                                  ===============           ==============
</TABLE>



NON ACCRUAL, PAST DUE AND RESTRUCTURED LOANS
--------------------------------------------

The Company's policy is to discontinue the accrual of interest income on loans
whenever it is determined that reasonable doubt exists with respect to timely
collectibility of interest and principal.  Loans are placed on nonaccrual status
if either material deterioration occurs in the financial position of the
borrower, payment in full of interest or principal is not anticipated, payment
in full of interest or principal is past due 90 days or more unless well
secured, payment in full of interest or principal on a loan is past due 180 days
or more, regardless of collateral, or the loan in whole or in part is classified
as doubtful. A loan may remain on accrual status if it is in the process of
collection and is either guaranteed or well secured. When a loan is placed on
nonaccrual status, interest is no longer accrued or included in interest income
and previously accrued income is reversed.

                                       10
<PAGE>
 
The following is a summary of the Company's problem loans as of June 30, 1998
and 1997.


<TABLE>
<CAPTION>
                                                                               At June 30,
                                                                         1998               1997
                                                                   --------------     --------------
<S>                                                                <C>                <C>
                                                                         (dollars in thousands)
 
Nonaccrual loans                                                   $          162                 92
Restructured loans                                                             --                 --
Other impaired loans                                                           --                 --
Other real estate                                                             184                175
                                                                   --------------     --------------
          Total non-performing loans                                          346                267
                                                                   ==============     ==============
 
Loans past due 90+ days and still accruing                                     30                 18
                                                                   ==============     ==============
 
Other potential problem loans                                                  --                 --
                                                                   ==============     ==============
 
Income that would have been recorded in
          accordance with original terms                                        5                  5
Less income actually recorded                                                  --                 --
                                                                   --------------     --------------
Loss of income                                                     $            5                  5
                                                                   ==============     ==============
</TABLE>


CONCENTRATION OF CREDIT RISK
----------------------------

The Company grants real estate, commercial, and industrial loans to customers
primarily in Henderson, Texas, and surrounding areas of east Texas. Although the
Company has a diversified loan portfolio, a substantial portion (approximately
48.5% at June 30, 1998) of its loans are secured by real estate and its ability
to fully collect its loans is dependent upon the real estate market in this
region. The Company typically requires collateral sufficient in value to cover
the principal amount of the loan. Such collateral is evidenced by mortgages on
property held and readily accessible to the Company. See additional information
related to the composition of the Company's loan portfolio included in note 3 to
the consolidated financial statements.

NEW EMPLOYEE BENEFIT PLANS
--------------------------

In June 1998, the Company established a non-qualified deferred compensation plan
and performance and retention plan for certain select management employees of
the Company.  Contributions by the Company are at the discretion of the Board of
Directors and generally provide vesting over five years.  As of June 30, 1998,
no awards have been granted.

CORPORATE OBJECTIVES
--------------------

It is the philosophy of the Company to continue to remain independent in
ownership, to foster its image as the community leader in banking, to increase
its market share through selected acquisitions and aggressive marketing, to
maintain a sound earning-asset portfolio, and to assess liquidity needs while
maximizing its profitability and return to its shareholders.

NEW ACCOUNTING PRONOUNCEMENTS
-----------------------------

In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133, "Accounting for Derivative Instruments
and Hedging Activities".  This Statement establishes accounting and reporting
standards for derivative instruments, including certain derivatives embedded in
other contracts, and for hedging activities.  It requires that an entity
recognizes all derivatives as either assets or liabilities in the balance sheet
and measures those instruments at fair value.  The Statement will be effective
for the Company in the fiscal year ending in 2000.  Due to the level of use of
derivatives of the Company, the effect of implementation of this new
pronouncement is not expected to have a significant effect on the financial
position or results of operations of the Company.

                                       11
<PAGE>
 
In April 1998, the Accounting Standards Executive Committee of the American
Institute of Certified Public Accountants issued Statement of Position (SOP) 98-
5, "Reporting on the Costs of Start-Up Activities".  SOP 98-5 requires that the
costs of start-up activities, including organizational costs, be expensed as
incurred.  SOP 98-5, effective for fiscal years beginning after December 15,
1998, requires initial application to be recorded as of the beginning of the
fiscal year in which  the SOP is first adopted and is reported as the cumulative
effect of a change in accounting principle.  Although certain capitalized costs
will be effected, the effect of implementation of this new pronouncement is not
expected to have a significant effect on the financial condition or results of
operations of the Company.


Item 3.
          QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

There have been no material changes in the information related to the market
risk of the Company since December 31, 1997.

                                       12
<PAGE>
 
Part II - OTHER INFORMATION

Item 1.  Legal Proceedings

   None


Item 2.  Changes in Securities

   None


Item 3.  Defaults Upon Senior Securities

   None


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

   None

Item 5.  Other Information

   None

Item 6.  Exhibits and Reports on Form 8-K

   None

                                       13
<PAGE>
 
SIGNATURES

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



                                 HENDERSON CITIZENS BANCSHARES, INC.


Date: August 11, 1998                   By:  /s/ Milton S. McGee, Jr.
      ---------------------                  -----------------------------------
                                             Milton S. McGee, Jr., CPA
                                             President



 
Date: August 11, 1998                   By:  /s/ Rebecca G. Tanner
      ---------------------                  -----------------------------------
                                             Rebecca G. Tanner, CPA
                                             Chief Accounting Officer

                                       14