<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: September 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 Classification    Identification No.)
      incorporation                  Code Number)
     or organization)


                      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 September 30, 1998, 2,016,874 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)
                   September 30, 1998 and December 31, 1997
                 (dollars in thousands, except share amounts)

<TABLE>
<CAPTION>

                                                                               1998                 1997    
                              Assets                                     --------------       --------------       
                              ------                                     
<S>                                                                      <C>                  <C>
Cash and due from banks                                                  $        7,381                8,886
Interest-bearing deposits with
     other financial institutions                                                 7,885                8,212
Federal funds sold                                                                6,245                5,040
Securities:
   Held-to-maturity, approximate market value of $66,125
     in 1998 and $69,598 in 1997                                                 64,955               69,233
   Available-for-sale                                                           133,258              148,740
                                                                         --------------       --------------
                                                                                198,213              217,973
Loans, net                                                                      120,040              106,061
Premises and equipment, net                                                       5,549                5,209
Accrued interest receivable                                                       3,165                3,311
Other assets                                                                      3,414                3,801
                                                                         --------------       --------------
                                                                         $      351,892              358,493
                                                                         ==============       ==============

                        Liabilities and Stockholders' Equity
                        ------------------------------------
Deposits:
   Demand - noninterest-bearing                                                  37,557               32,860
   Interest-bearing transaction accounts                                         70,743               79,810
   Money market and savings                                                      43,811               46,206
   Certificates of deposit and other time deposits                              161,948              163,231
                                                                         --------------       --------------
                      Total deposits                                            314,059              322,107
Accrued interest payable                                                          1,083                1,105
Notes payable                                                                       444                  844
Other liabilities                                                                   909                1,708
                                                                         --------------       --------------
                                                                                316,495              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                                                             20,663               18,875
   Accumulated other comprehensive income                                           554                 (335)
                                                                         --------------       --------------
                                                                                 37,417               34,740
  Less treasury stock, 143,126 shares in 1998 and 142,506 shares                 
        in 1997, at cost                                                         (2,020)              (2,011)
                                                                         --------------       --------------
                        Total stockholders' equity                               35,397               32,729
Commitments and contingencies
                                                                         --------------       --------------
                                                                         $      351,892              358,493
                                                                         ==============       ==============
See accompanying notes to consolidated financial statements.
</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                         Nine months
                                                                      ended September 30,                  ended September 30,
                                                                --------------------------------     -------------------------------

                                                                     1998               1997              1998               1997
                                                                -------------     --------------     -------------     -------------

<S>                                                             <C>               <C>                <C>               <C>
Interest income:
   Loans                                                        $       2,470              2,163             7,128             6,387

   Securities
        Taxable - available-for-sale                                    2,032              2,204             6,359             6,734
        Taxable - held-to-maturity                                        409                623             1,407             1,949
        Tax-exempt                                                        436                468             1,179             1,367
   Federal funds sold                                                      60                 33               251               119
   Interest-bearing deposits with other financial                         109                 55               420               213
    institutions
                                                                -------------     --------------     -------------     -------------
          Total interest income                                         5,516              5,546            16,744            16,769
                                                                -------------     --------------     -------------     -------------

Interest expense:
   Deposits:
        Transaction accounts                                              449                453             1,414             1,443
        Money market and savings                                          309                316               951               955
        Certificates of deposit and other time deposits                 2,069              2,073             6,259             6,265
   Other                                                                   10                 14                25                40
                                                                -------------     --------------     -------------     -------------
          Total interest expense                                        2,837              2,856             8,649             8,703
                                                                -------------     --------------     -------------     -------------

          Net interest income                                           2,679              2,690             8,095             8,066

Provision for loan losses                                                 165                 83               458               253
                                                                -------------     --------------     -------------     -------------
          Net interest income after provision for loan                  
           losses                                                       2,514              2,607             7,637             7,813
                                                                -------------     --------------     -------------     -------------
 
Other income:
        Gains (losses) on securities transactions, net                    216                 27               282              (37)
        Income from fiduciary activities                                  197                156               602               444
        Service charges, commissions, and fees                            802                509             2,209             1,401
        Other                                                             134                 91               421               249
                                                                -------------     --------------     -------------     -------------
          Total other income                                            1,349                783             3,514             2,057
                                                                -------------     --------------     -------------     -------------

Other expenses:
        Salaries and employee benefits                                  1,448              1,339             4,374             4,005
        Occupancy and equipment                                           362                266             1,000               752
        Regulatory assessments                                             38                 33               102                93
        Other                                                             745                648             2,175             1,883
                                                                -------------     --------------     -------------     -------------
          Total other expenses                                          2,593              2,286             7,651             6,733
                                                                -------------     --------------     -------------     -------------

          Income before income taxes                                    1,270              1,104             3,500             3,137

Income tax expense                                                        262                252               744               714
                                                                -------------     --------------     -------------     -------------
               Net income                                       $       1,008                852             2,756             2,423
                                                                =============     ==============     =============     =============
 
               Basic net income per common share                $         .50               0.40              1.37              1.14
                                                                =============     ==============     =============     =============
 
               Average number of shares outstanding                 2,017,198          2,115,871         2,017,390         2,122,551
                                                                =============     ==============     =============     =============
</TABLE> 
 
See accompanying notes to consolidated financial statements.

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

                Consolidated Statements of Stockholders' Equity
                                  (unaudited)

                 Nine months ended September 30, 1998 and 1997
          (dollars in thousands, except share and 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                                --        --         --       2,423                 --           --            2,423
 
     Net change in unrealized
      losses on securities
      available for sale                       --        --         --          --                261           --              261
      
     Cash dividends ($.48 per                 
      share)                                   --        --         --      (1,017)                --           --           (1,017)

     Purchase of 14,620 shares of             
      treasury stock                           --        --         --          --                 --         (177)            (177)
                                      -----------  --------   ---------   --------   ----------------     ----------   -------------
Balances at September 30, 1997        $        --    10,800      5,400      18,231               (442)        (511)          33,478
                                      ===========  ========   =========   ========   ================     ==========   =============

 
Balances at December 31, 1997         $        --    10,800      5,400      18,875               (335)      (2,011)          32,729
 
     Net income                                --        --         --       2,756                 --           --            2,756
 
     Net change in unrealized gains
     on securities available for               
      sale                                     --        --         --          --                889           --              889
 
     Cash dividends ($.48 per                  
      share)                                   --        --         --        (968)                --           --             (968)

      Purchase of 620 shares of                 
      treasury stock                           --        --         --          --                 --           (9)              (9)
                                      -----------  --------   ---------   --------   ----------------     ----------   -------------
Balances at September 30, 1998        $        --    10,800      5,400      20,663                554       (2,020)          35,397
                                      ===========  ========   =========   ========   ================     ==========   =============
</TABLE>

See accompanying notes to consolidated financial statements.

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

                     Consolidated Statement of Cash Flows
                                  (unaudited)

                 Nine months ended September 30, 1998 and 1997
                            (dollars in thousands)

<TABLE>
<CAPTION>
                                                                                            1998                 1997
                                                                                      --------------       --------------
<S>                                                                                   <C>                  <C>
Operating activities:
     Net income                                                                       $        2,756                2,423
     Adjustments to reconcile net income to net cash
        provided by operating activities:
               Net amortization of premium on securities                                         327                  273
               Net (gains) losses on securities transactions, net                               (282)                  37
               Provision for loan losses                                                         458                  253
               Depreciation and amortization                                                     783                  453
               Decrease in accrued interest receivable                                           146                  115
               Increase in other assets                                                          (98)                (543)
               Increase (decrease) in accrued interest payable                                   (22)                 188
               Decrease in other liabilities                                                    (762)                (712)
                                                                                      --------------       --------------
                    Net cash provided by operating activities                                  3,306                2,487
                                                                                      --------------       --------------
 
Investing activities:
     Proceeds from maturities and paydowns of held-to-maturity securities                     19,458               16,425
     Purchases of held-to-maturity securities                                                (15,390)              (6,126)
     Proceeds from sales of available-for-sale securities                                     31,323               20,823
     Proceeds from maturities and paydowns of available-for-sale securities                   36,511                8,368
     Purchases of available-for-sale securities                                             ( 50,839)             (24,692)
     Net increase in loans                                                                   (14,437)              (3,840)
     Purchases of bank premises and equipment                                                   (811)              (1,693)
                                                                                      --------------       --------------
                    Net cash provided by investing activities                                  5,815                9,265
                                                                                      --------------       --------------
 
Financing activities:
     Net decrease in deposits                                                                 (8,048)             (11,272)
     Payment on notes payable                                                                   (400)                (667)
     Cash dividends paid                                                                      (1,291)              (1,017)
     Purchase of treasury stock                                                                   (9)                (177)
                                                                                      --------------       --------------
                    Net cash used in financing activities                                     (9,748)             (13,133)
                                                                                      --------------       --------------
 
                    Decrease in cash and cash equivalents                                       (627)              (1,381)
Cash and cash equivalents at beginning of period                                              22,138               17,455
                                                                                      --------------       --------------
 
Cash and cash equivalents at end of period                                            $       21,511               16,074
                                                                                      ==============       ==============
 
Supplemental disclosures of cash flow activities:
Income taxes paid, net of refunds                                                     $          970                  865
                                                                                      ==============       ==============
 
Interest paid                                                                         $        8,671                8,515
                                                                                      ==============       ==============
</TABLE>
 
See accompanying notes to consolidated financial statements.

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

                  Notes to Consolidated Financial Statements

                              September 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 September 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                             $       7,020                20                --               7,040
U.S. Government agencies                          3,083                20                --               3,103
State and municipal                              40,563             1,001               (20)             41,544
Mortgage-backed securities
 and collateralized mortgage
 obligations                                     14,289               151                (2)             14,438
                                          -------------     -------------    --------------      --------------
                                          $      64,955             1,192               (22)             66,125
                                          -------------     -------------    --------------      --------------
</TABLE> 
     The amortized cost and approximate market values (carrying value) of
        securities available- for-sale at September 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                             $      49,673               825                --              50,498
U.S. Government agencies                         17,465                80                (1)             17,544
Mortgage-backed securities
 and collateralized mortgage
 obligations                                     64,913               279              (343)             64,849
  Other                                             367                --                --                 367
                                          -------------     -------------    --------------      --------------
                                          $     132,418             1,184              (344)            133,258
                                          -------------     -------------    --------------      --------------
</TABLE>

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

                  Notes to Consolidated Financial Statements

                              September 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>
 
                                                                    September 30,            December 31,
                                                                        1998                     1997
                                                                ------------------       -----------------
<S>                                                             <C>                      <C>                      
               Commercial and industrial                        $           30,848                  28,195
               Real estate mortgage                                         60,717                  49,979
               Installment and other                                        30,473                  29,832
                                                                ------------------       -----------------
                         Total                                             122,038                 108,006
 
               Less:
                  Allowance for loan losses                                 (1,535)                 (1,249)
                  Unearned discount                                           (463)                   (696)
                                                                ------------------       -----------------
                         Loans, net                             $          120,040                 106,061
                                                                ==================       =================
</TABLE> 
 
     Changes in the allowance for loan losses for the nine months ended
     September 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                       458                     253
                  Loans charged off                                           (328)                   (261)
                  Recoveries on loans                                          156                      88
                                                                ------------------       -----------------
               Balance, September 30                            $            1,535                   1,226
                                                                ==================       =================
</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 nine-month periods ended September 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 nine-month periods ended September 30, 1998 and 1997, were
     $3,645,000 and $2,684,000, respectively and for the three-month periods
     ended September 30, 1998 and 1997, were $1,493,000 and 1,234,000,
     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 NINE MONTHS ENDED SEPTEMBER 30, 1998 AND 1997


The following discussion and analysis of the financial condition and results of
operations of the Company and its primary bank subsidiary, Citizens National
Bank, Henderson, 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 nine months of 1998 increased to $2,756,000 compared to
$2,423,000 for the same period in 1997.  The increase was primarily caused by an
increase in non-interest income. During the first nine months of 1998, net
interest income increased slightly due to increased loan demand although loan
and deposit interest rates generally remained unchanged. The Company made a
provision of $458,000 to the allowance for loan losses during the first nine
months of 1998.  A provision of $253,000 was made for loan losses during the
same period in 1997. The Company experienced a gain on securities transactions
totaling approximately $282,000 in the first nine months of 1998 compared to
losses of $37,000 in the first nine months of 1997.  Other income, excluding
gains on securities transactions, for the first nine months of 1998 was
$3,232,000 compared to $2,094,000 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 nine months
of 1998 were $7,651,000 compared to $6,733,000 for the same period in 1997.
Income tax expense for the first nine months of 1998 and 1997 was $744,000 and
$714,000, 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 $6,150,200.  The acquisition of Jefferson National Bank will result in an
increase in total assets of the Company of approximately $32,977,000, total
loans of approximately $7,779,000, and total deposits of approximately
$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
---------------------------------

The sole banking office of First State Bank, Waskom, Texas, previously a wholly
owned subsidiary but separate bank charter, 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 nine months ended September 30, 1998, net interest income was $8,095,000
compared to $8,066,000 for the first nine months of 1997. The slight increase is
primarily the result of continued loan growth. Loan and deposit interest rates
generally remained unchanged.

Net interest income for the three-month period ended September 30, 1998 was
relatively unchanged at $2,679,000 compared to $2,690,000 in 1997.

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

During the first nine months of 1998, the Company increased its allowance for
loan losses through a provision of $458,000. The Company increased its allowance
for loan losses during the same period of 1997 by $253,000. 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 $172,000 in the first nine months of
1998 compared to net charge-offs of $173,000 in the same period in 1997.

For the three-month period ended September 30, 1998, the Company increased its
allowance through a provision of $165,000.  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 $3,232,000 for the
first nine months of 1998 as compared to $2,094,000 in the first nine months of
1997. This increase is due to increases in service charges primarily 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 net gains on securities
transactions for the first nine months of 1998 of $282,000 compared to net
losses on securities transactions for the first nine months of 1997 of $37,000.
Other expenses for the nine-month period ended September 30, 1998 were
$7,651,000 compared to $6,733,000 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 September 30, 1998, non-interest income, excluding
securities losses was $1,133,000 compared to $756,000 for the same period in
1997, with the majority of the increase due to insufficient funds fee income.
The Company experienced net gains on securities transactions in the three months
ended September 30, 1998 of approximately $216,000 compared to net gains on
securities transactions of $27,000 for the three months ended September 30,
1997.

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

Income tax expense for the first nine months of 1998 was $744,000, compared to
$714,000 in the same period in 1997. The effective tax rate for the first nine
months of 1998 and 1997, respectively, was 21.3% and 22.8%.  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 September 30, 1998 and
September 30, 1997 were $262,000 and $252,000 respectively.

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

The Company's total assets at September 30, 1998 of $351,892,000 decreased from
the total assets at December 31, 1997 of $358,493,000.  Total deposits were
$314,059,000 at September 30, 1998, compared to the December 31, 1997 total of
$322,107,000.  These slight decreases are primarily seasonal fluctuations.  The
Company's loan portfolio grew 13.2% to $120,040,000 at September 30, 1998, up
from $106,061,000 at December 31, 1997, due to a significant increase in real
estate loans. The increase in real estate loans was primarily due to the
availability of home equity loans combined with the addition of a loan
production office in Corsicana, Texas.

Equity capital of the Company, excluding unrealized gains or losses on
securities available for sale, as a percentage of total assets was 9.9% at
September 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 23.2%, 24.3%, and 9.7%, respectively at September 30, 1998 compared
to 23.7%, 24.7%, and 9.1%, respectively, at December 31, 1997.

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

At September 30, 1998, the Company's cash and cash equivalents of $21,511,000
decreased slightly from the December 31, 1997 amount of $22,138,000.  The
Company's stockholders' equity at September 30, 1998, of $35,397,000 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 September 30, 1998 and December 31, 1997 was
1.26% 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 September
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 Nine Months Ended
                                                                                 September 30,
                                                                         1998                      1997
                                                                  ---------------            --------------
<S>                                                               <C>                        <C>                        
Balance at beginning of period                                    $         1,249                     1,146
Charge-offs:
          Commercial, financial, and agricultural                              25                        57
          Real estate-mortgage                                                 --                         1
          Installment loans to individuals                                    303                       203
                                                                  ---------------            --------------
                                                                              328                       261
Recoveries:
          Commercial, financial, and agricultural                              54                        41
          Installment loans to individuals                                    102                        47
                                                                  ---------------            --------------
                                                                              156                        88
                                                                  ---------------            --------------
Net charge-offs                                                              (172)                     (173)
                                                                  ---------------            --------------
Additions charged to operations                                               458                       253
                                                                  ---------------            --------------
Balance at end of period                                          $         1,535                     1,226
                                                                  ===============            ==============
Ratio of net charge-offs during
          the period to average loans outstanding
          during the period                                                   .14%                      .16%
                                                                  ===============            ==============
</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 September 30,
1998 and 1997.

<TABLE>
<CAPTION>
                                                                            At September 30,
                                                                         1998               1997
                                                                   --------------     --------------
                                                                         (dollars in thousands)
 <S>                                                                <C>                <C>                
Nonaccrual loans                                                   $          149                 88
Restructured loans                                                             --                 --
Other impaired loans                                                           --                 --
Other real estate                                                              --                150
                                                                   --------------     --------------
          Total non-performing loans                                          149                238
                                                                   ==============     ==============
Loans past due 90+ days and still accruing                                    182                 44
                                                                   ==============     ==============
Other potential problem loans                                                  --                 --
                                                                   ==============     ==============
 
Income that would have been recorded in
          accordance with original terms                                        7                  6
Less income actually recorded                                                  --                 --
                                                                   --------------     --------------
Loss of income                                                     $            7                  6
                                                                   ==============     ==============
</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
49.8% at September 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 September 30,
1998, no awards have been granted.

SECURITIES
----------

The Investment Committee, under the guidance of the Company's Investment Policy,
assesses the short and long-term needs of the Company after consideration of
loan demand, interest rate factors, and prevailing market conditions.
Recommendations for purchases and other transactions are then made considering
safety, liquidity, and maximization of return to the Company.  Management
determines the proper classification of securities at the time of purchase.
Securities that management does not intend to hold to maturity or that might be
sold under certain circumstances are classified as available for sale.  If
management has the intent and the Company has the ability at the time of
purchase to hold the securities until maturity, the securities will be
classified as held to maturity.

The management strategy for securities is to maintain a very high quality
portfolio with generally short duration.  The quality of the portfolio is
maintained with 79% of the total comprised of U.S. Treasury, federal agency
securities, and agency issued mortgage securities.  Treasury holdings are
currently positioned in a ladder structure.  Three-year treasury bonds are
purchased quarterly, held for two years, then sold with one year left to
maturity to take advantage of the slope in the yield curve.  The collateralized
mortgage obligations (CMOs) and mortgage backed securities (MBS) held by the
company are backed by agency collateral which consists of loans issued by the
Federal Home Loan Mortgage Corporation (FHLMC), Federal National Mortgage
Corporation (FNMA), and the Government National Mortgage Association (GNMA) with
a blend of fixed and floating rate coupons.

                                       11
<PAGE>
 
Credit risk is minimized through agency backing, however, there are other risks
associated with MBS and CMOs.  These other risks include prepayment, extension,
and interest rate risk.  MBS are securities which represent an undivided
interest in a pool of mortgage loans.  CMOs are structured obligations that are
derived from a pool of mortgage loans or agency mortgage backed securities.
CMOs in general have widely varying degrees of risk, which results from the
prepayment risk on the underlying mortgage loans and its effect on the cash
flows of the security.

Prepayment risk is the risk of borrowers paying off their loans sooner than
expected in a falling rate environment by either refinancing or curtailment.
Extension risk is the risk that the underlying pool of loans will not exhibit
the expected prepayment speeds thus resulting in a longer average life and
slower cash flows than anticipated at purchase.  Interest rate risk is based on
the sensitivity of yields on assets that change in a different time period or in
a different proportion from that of current market interest rates.  Changes in
average life due to prepayments and changes in interest rates in general will
cause the market value of MBS and CMOs to fluctuate.

The Company's MBS portfolio consists of fixed rate balloon maturity pools with
short stated final maturities and adjustable rate mortgage (ARM) pools with
coupons that reset annually and have longer maturities.  Investments in CMOs
consist mainly of Planned Amortization Classes (PAC), Targeted Amortization
Classes (TAC), and sequential classes.  Floating rate securities make up 75% of
the CMO portfolio.  Support and liquidity classes with longer average lives and
floating rate coupons are a relatively small portion of the portfolio.

To maximize after-tax income, investments in tax-exempt municipal securities are
utilized but with somewhat longer maturities.

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.

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.

YEAR 2000
---------

The Company recognizes that the arrival of the Year 2000 poses a unique
challenge to the ability of all systems to recognize the date change from
December 31, 1999 to January 1, 2000 and, like other companies, has assessed and
is repairing its computer applications and business processes to provide for
their continued functionality.   Efforts to address and resolve this issue are
continuing, including a process of inventory, scoping and analysis,
modification, testing and certification, and implementation.  An assessment of
the readiness of external entities with which the Company interfaces, such as
vendors, customers, payment systems, and others, is also ongoing.  Currently,
the Company is in the process of developing a contingency plan should its
current Year 2000 plans not be successful and anticipates completion of this
plan in the fourth quarter of 1998.

                                       12
<PAGE>
 
A major portion of the costs associated with correcting Year 2000 deficiencies
will be met from existing resources through a reprioritization of technology
development initiatives, with the remainder representing incremental costs.  The
Company estimates that it will incur costs for testing of computer applications
and purchases of certain new hardware and software.  Certain of these hardware
improvements would have been made regardless of the Year 2000 issues based on
the Company's history of technology upgrades.  It is anticipated that the
Company will be Year 2000 compliant by early 1999.  The Company does not expect
that the related overall costs of Year 2000 issues will have a significant
effect on the financial condition or results of operations of the Company.

Words or phrases when used in this Form 10-Q or other filings with the
Securities and Exchange Commission, such as "does not expect" and "anticipates",
or similar expressions are intended to identify "forward-looking statements"
within the meaning of the Private Securities Litigation Reform Act of 1995.

                                       13
<PAGE>
 
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.

                                       14
<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

                                       15
<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: November 9, 1998              By:  /s/ Milton S. McGee, Jr.
      ----------------                   ------------------------------
                                         Milton S. McGee, Jr., CPA
                                         President



 
Date: November 9, 1998              By:  /s/ Rebecca G. Tanner
      ----------------                   ----------------------------
                                         Rebecca G. Tanner, CPA
                                         Chief Accounting Officer

                                       16