<PAGE>   1
                       SECURITIES AND EXCHANGE COMMISSION
                             Washington, D.C. 20549

                                   FORM 10-K

           [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
                        SECURITIES EXCHANGE ACT OF 1934
                  FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998

          [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
                        SECURITIES EXCHANGE ACT OF 1934
               For the Transition Period From _______ to _______.

                        Commission File Number: 811-3780

                               PMC CAPITAL, INC.
             (Exact name of registrant as specified in its charter)

            FLORIDA                                       59-2338539
(State or other jurisdiction of                        (I.R.S. Employer
incorporation or organization)                        Identification No.)

18111 PRESTON ROAD, SUITE 600, DALLAS, TX 75252          (972) 349-3200
   (Address of principal executive offices)      (Registrant's telephone number)

          Securities registered pursuant to Section 12(b) of the Act:
                          COMMON STOCK, $.01 PAR VALUE

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. YES [X] NO [ ]

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of the Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [X]

The aggregate market value of the voting stock held by non-affiliates of the
registrant, based upon the closing sale price of the Common Stock on February
26, 1999 as reported on the American Stock Exchange, was approximately $79
million. Common Stock held by each officer and director and by each person who
owns 10% or more of the outstanding Common Stock have been excluded because
such persons may be deemed to be affiliates. This determination of affiliate
status is not necessarily a conclusive determination for other purposes.

As of February 26, 1999, the Registrant had 11,829,116 shares of Common Stock
outstanding.

                      DOCUMENTS INCORPORATED BY REFERENCE:

Portions of the Registrant's Proxy Statement to be filed with the Securities
and Exchange Commission within 120 days after the year covered by this Form
10-K with respect to the Annual Meeting of Shareholders to be held on May 12,
1999 are incorporated by reference into Part III.

<PAGE>   2

                               PMC CAPITAL, INC.
                                   FORM 10-K
                      FOR THE YEAR ENDED DECEMBER 31, 1998

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


                               TABLE OF CONTENTS


<TABLE>
<CAPTION>
                                                                                                      Form
                                                                                                      10-K
                                                                                                     Report
Item                                                                                                  Page
----                                                                                                  ----
<S>      <C>                                                                                         <C>

                                                    PART I

   1.    Business................................................................................        1
   2.    Properties..............................................................................        9
   3.    Legal Proceedings.......................................................................        9
   4.    Submission of Matters to a Vote of Security Holders.....................................        9


                                                    PART II

   5.    Market for the Registrant's  Common Stock and Related Shareholder Matters...............       10
   6.    Selected Consolidated Financial Data....................................................       11
   7.    Management's Discussion and Analysis of Financial Condition and 
              Results of Operations..............................................................       12
   7A.   Quantitative and Qualitative Disclosures about Market Risk..............................       22
   8.    Consolidated Financial Statements and Supplementary Data................................       22
   9.    Changes in and Disagreements with Accountants on Accounting and
              Financial Disclosure...............................................................       22

                                                    PART III

  10.    Directors and Executive Officers of the Registrant......................................       23
  11.    Executive Compensation..................................................................       23
  12.    Security Ownership of Certain Beneficial Owners and Management..........................       23
  13.    Certain Relationships and Related Transactions..........................................       23

                                                      PART IV

  14.    Exhibits, Financial Statements, Schedules and Reports
              on Form 8-K........................................................................       24

  Signatures.....................................................................................       25
  Financial Statements...........................................................................       F-1
  Exhibits.......................................................................................       E-1
</TABLE>

<PAGE>   3

                                    PART I

ITEM 1. BUSINESS

GENERAL

        PMC Capital, Inc. ("PMC Capital" or "PMC", and together with its
subsidiaries, the "Company") is a diversified closed-end management investment
company that operates as a business development company ("BDC") under the
Investment Company Act of 1940, as amended (the "1940 Act"). The common stock
of the Company (the "Common Stock") is traded on the American Stock Exchange
under the symbol "PMC." PMC Capital has elected to be taxed as a regulated
investment company and distributes substantially all its taxable income as
dividends to its shareholders, thereby incurring no Federal income tax
liability on such income.

        The Company primarily engages in the business of originating loans to
small businesses either directly or through its three principal subsidiaries:
First Western SBLC, Inc. ("First Western"), PMC Investment Corporation
("PMCIC") and Western Financial Capital Corporation ("Western Financial"). The
Company primarily originates loans to individuals and small business concerns
in the lodging industry. The Company also targets the medical, food service,
service, retail and commercial real estate industries. The Company is a
national lender that primarily lends to businesses in the Southwest and
Southeast regions of the United States. A majority of the Company's loans in
the lodging industry are to owner-operated facilities generally operating under
national franchises. The Company believes that franchise operations offer
attractive lending opportunities because such businesses generally employ
proven business concepts, have national reservation systems, have consistent
product quality, are screened and monitored by franchisors and generally have a
higher rate of success as compared to other independently operated businesses.
During the years ended December 31, 1998 and 1997, the Company funded $66.4
million and $86.4 million in loans, respectively. The decrease of $20.0 million
was primarily related to a decrease in lending by First Western of
approximately $19 million. In addition, fundings by PMC, PMCIC, and Western
Financial were predominately through fixed-rate loan originations during 1998
as compared to a majority of variable-rate loan originations during 1997.

        In addition to the Company's lending operations, it earns revenue
through its investment advisor subsidiary, PMC Advisers, Ltd., which evaluates
and services loans and other investment alternatives pursuant to a fee
arrangement with PMC Commercial Trust ("PMC Commercial"). PMC Commercial is a
real estate investment trust and an affiliate of the Company. PMC Commercial
provides loans to persons or entities whose borrowing needs and/or strength and
stability exceed the limitations set for SBA approved loan programs and invests
in commercial real estate. As a result, PMC Commercial and the Company
generally pursue different prospective borrowers. In order to further mitigate
the potential for conflicts of interest, PMC Commercial, PMC Capital and PMC
Advisers, Ltd. have entered into a Loan Origination Agreement. Pursuant to the
Loan Origination Agreement, loans which meet PMC Commercial's underwriting
criteria are to be first presented to PMC Commercial for funding. If PMC
Commercial does not have available funds, origination opportunities presented
to PMC Commercial may be originated by the Company.

        PMC Capital was incorporated in Florida under the name of Pro-Med
Capital, Inc. in June 1983 and changed its name to "PMC Capital, Inc." in March
1991. First Western, PMCIC and Western Financial are registered under the 1940
Act as diversified closed-end management investment companies. The principal
executive offices of the Company are located at 18111 Preston Road, Suite 600,
Dallas, Texas 75252.

        Earnings per share on a quarterly basis since 1989 were as follows:

<TABLE>
<CAPTION>
                    1998      1997      1996      1995     1994      1993      1992      1991      1990      1989
                   ------    ------    ------    ------   ------    ------    ------    ------    ------    ------
<S>                <C>       <C>       <C>       <C>      <C>       <C>       <C>       <C>       <C>       <C>  
1st Quarter         $0.28     $0.29     $0.27     $0.23    $0.19     $0.18     $0.18     $0.15     $0.13     $0.09
2nd Quarter          0.28      0.31      0.30      0.25     0.23      0.23      0.23      0.15      0.12      0.11
3rd Quarter          0.29      0.30      0.30      0.27     0.26      0.25      0.19      0.18      0.13      0.10
4th Quarter*         0.31      0.45      0.31      0.28     0.44      0.21      0.19      0.16      0.14      0.11
                    -----     -----     -----     -----    -----     -----     -----     -----     -----     -----
                    $1.16     $1.35     $1.18     $1.03    $1.12     $0.87     $0.79     $0.64     $0.52     $0.41
                    =====     =====     =====     =====    =====     =====     =====     =====     =====     =====
</TABLE>

*       Includes $0.08 in 1998, $0.21 in 1997 and $0.24 in 1994 relating to
        structured sales of portions of the loan portfolio.


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<PAGE>   4

LENDING PROGRAMS

        FIRST WESTERN. First Western is a small business lending company
("SBLC") that originates variable-rate loans which are partially guaranteed by
the Small Business Administration ("SBA") pursuant to its Section SBA 7(a)
Program (the "SBA 7(a) Program").

        At December 31, 1998 and 1997, First Western had outstanding loans
receivable, net, in an aggregate amount of $8.9 million and $8.2 million,
respectively. During December 1997, First Western completed a securitization
and structured sale of $22.8 million of its unguaranteed SBA loan portfolio
(the "First Western Securitization"). This transaction was rated by Moody's
Investors Service in two traunches with the majority (93%) rated "Aaa" and the
subordinated piece (7%) rated "A1". During the years ended December 31, 1998
and 1997, First Western originated $10.6 million and $29.5 million,
respectively, in loans and sold $10.0 million and $21.6 million, respectively,
of the government guaranteed portion of its loans into the secondary market
(without recourse to the Company). At December 31, 1998 and 1997, First Western
had loans receivable with aggregate balances of approximately $263,000 and
$104,000 (2.9% and 1.2%, respectively, of First Western's outstanding loans
receivable, net) greater than 60 days past due, respectively. Realized and
unrealized gains (losses) on First Western's retained loans were a net $39,000
gain and a $111,000 loss during the years ended December 31, 1998 and 1997,
respectively.

        The fees charged to the borrower by the SBA for the SBA's guaranty of a
loan to the lender are based on the size of the originated loan and range from
2% to 3.875% of the guaranteed portion of the loan. These fees, which are
passed directly to the borrower, have increased by up to 73% since 1996. First
Western's decrease in loan origination volume during 1998 and 1997 results from
these increased fees, an increase in competition from other SBA lenders and
other alternative loan products. Due to the decrease in First Western's loan
origination volume as well as declines in the market for premiums, the premiums
recognized from the sale of the government guaranteed portion of SBA 7(a)
Program loans sold in the secondary market decreased from $1,942,000 during
1996 to $1,776,000 in 1997 and $776,000 in 1998.

        The difficulties in finding suitable lending opportunities due to
higher fees and increased competition caused the Company to place less reliance
during 1997 and 1998 on the SBA 7(a) Program lending activities. Despite this
reduced emphasis on SBA lending, continued program and market changes may have
an adverse effect on future periods of operations. The impact of the Company's
SBA 7(a) Program lending activities on the Company's earnings have been and
will be affected by a number of factors including: (i) the timing and
availability of portfolio for securitizations (see "Securitization and
Structured Financing Programs"), (ii) the volume of SBA 7(a) Program lending,
(iii) the length of SBA 7(a) Program loans, (iv) the structure of sales to the
secondary market, (v) the interest rates charged and related terms, (vi) the
quality of the SBA 7(a) Program portfolio, (vii) prepayment experience (see
"Prepayment Considerations") and (viii) legislative and/or regulatory changes.
Any other aspect of SBA programs under which the Company participates could be
modified by legislation or agency policy changes. Presently, the SBA is
considering amending the program which may enhance the ability of the Company
to increase originations through the SBA 7(a) Program. Some of these changes
relate to a reduction in the fees charged to the borrower and an increase in
the guaranty percentage of smaller loans. However, the SBA is also considering
for the first time in many years the issuance of new licenses to non-bank
lenders to permit their use of the SBA 7(a) Program. PMC Capital has
established alternative lending strategies to address the above noted changes
and would pursue additional strategies should the SBA programs under which any
of its subsidiaries operates were to be eliminated or significantly curtailed.
See "Management's Discussion and Analysis of Financial Condition and Results of
Operations" .

        PMCIC. PMCIC is a licensed specialized small business investment
company ("SSBIC") under the Small Business Investment Act of 1958, as amended
("SBIA"). PMCIC uses long-term funds provided by the SBA, together with its own
capital, to provide long-term, collateralized loans to eligible small
businesses owned by "disadvantaged" persons, as defined under the regulations
of the SBA. As an SBIC, PMCIC is eligible to obtain long-term, fixed-rate
funding from the SBA through the issuance of debentures which are guaranteed by
the SBA. For any debentures issued by PMCIC prior to 1996, the interest rate
has been reduced through an SBA subsidy by 3% during the first five years.
Issuance of debentures is subject to SBA approval and availability. At December
31, 1998, PMCIC had received a commitment from the SBA for issuance of up to $5
million of SBA debentures. See "Overview of SBA Regulations."

        At December 31, 1998 and 1997, PMCIC had loans receivable, net, in an
aggregate amount of $43.2 million and $48.9 million, respectively. During the
years ended December 31, 1998 and 1997, PMCIC originated $14.1 million


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<PAGE>   5

and $24.1 million in loans, respectively. During the year ended December 31,
1998, PMCIC transferred $14.5 million in loans to PMC Capital in conjunction
with a structured sale of loans (the "1998 Structured Sale"). At December 31,
1998 and 1997, PMCIC had loans receivable with aggregate balances greater than
60 days past due of approximately $713,000 and $873,000, respectively (1.7% and
1.8%, respectively, of PMCIC's loans receivable, net). Realized and unrealized
losses on PMCIC's investments were $350,000 and $124,000 during the years ended
December 31, 1998 and 1997, respectively.

        WESTERN FINANCIAL. Western Financial is a licensed small business
investment company ("SBIC") under the SBIA that provides loans to small
business concerns and persons whether or not they qualify as "disadvantaged."
As an SBIC, Western Financial is eligible to obtain long-term, fixed-rate
funding from the SBA through the issuance of debentures. Issuance of debentures
is subject to SBA approval and availability. At December 31, 1998, Western
Financial has received a commitment from the SBA for issuance of up to $6.5
million of SBA debentures. See "Overview of SBA Regulations."

        At December 31, 1998 and 1997, Western Financial had loans receivable,
net, in an aggregate amount of $21.2 million and $21.9 million, respectively.
During the years ended December 31, 1998 and 1997, Western Financial originated
$12.0 million and $12.9 million in loans, respectively. During the year ended
December 31, 1998, Western Financial transferred $7.8 million in loans to PMC
Capital in conjunction with the 1998 Structured Sale. At December 31, 1998 and
1997, Western Financial had loans receivable with aggregate principal balances
greater than 60 days past due of approximately $116,000 and $153,000,
respectively (0.5% and 0.7%, respectively, of Western Financial's loans
receivable, net). Realized and unrealized losses on Western Financial's
investments were $8,000 and $7,000, respectively, during the years ended
December 31, 1998 and 1997.

        PMC CAPITAL. PMC Capital originates both fixed-rate and variable-rate
loans to borrowers on a non-SBA supported basis using criteria similar to that
utilized by its three principal investment company subsidiaries whose loans are
funded under the SBA programs. These loans are: (i) to borrowers who exceed the
eligibility requirements of the SBA 7(a) Program or SBIC programs, (ii) payable
in monthly installments of principal and interest based upon four to 25 year
amortization periods, with the balance due at maturity (typically four to 20
years), (iii) primarily collateralized by real estate, (iv) contain prepayment
fee provisions and (v) generally guaranteed by the principals of the borrowers.
The funding for this lending program is limited to the extent of leverage
available to PMC Capital.

        At December 31, 1998 and 1997, PMC Capital had loans receivable, net,
in an aggregate amount of $43.4 million and $48.3 million, respectively. During
the years ended December 31, 1998 and 1997, PMC Capital originated $29.7
million and $19.9 million in loans, respectively, and during the year ended
December 31, 1998 contributed $43.4 million in loans to the 1998 Partnership
(including the $22.3 million in loans transferred from PMCIC and Western
Financial to PMC Capital in conjunction with the 1998 Structured Sale). At
December 31, 1998 and 1997, PMC Capital had a loan receivable with an aggregate
balance greater than 60 days past due of approximately $464,000 and $461,000,
respectively (1.0% and 1.0% of PMC Capital's loans receivable, net). PMC
Capital had no realized or unrealized losses during the years ended December
31, 1998 and 1997.

        PRIME LENDING PROGRAM. Late in the fourth quarter of 1996, the Company
through PMC, PMCIC and Western Financial, began marketing a new variable rate
lending program (the "Prime Lending Program") which is separate from the SBA
7(a) Program of First Western, the Company's other variable rate lending
program. The Prime Lending Program was designed to refinance existing real
estate collateralized commercial loans with applicants who have proven timely
payment histories and loan-to-value and debt coverage ratios within the
Company's underwriting criteria. Loans funded within the Prime Lending Program
have variable interest rates based on the Prime Rate (as defined below). As of
December 31, 1998, the Company had funded over $50 million in the Prime Lending
Program with a weighted average interest rate of approximately 1.3% above the
Prime Rate. Substantially all of these loans were originated during the year
ended December 31, 1997. During 1998, the Company reduced its marketing effort
to originate new loans under the Prime Lending Program until a securitization
transaction of such loans was completed. Most of the loans originated under the
Prime Lending Program were sold as part of the 1998 Structured Sale. Management
of the Company is presently assessing increasing the marketing effort for the
Prime Lending Program.

        B & I LOAN PROGRAM. Additionally, the Company was approved in March
1997 as a licensee under the Rural Economic Development Business and Industry
Loan Program sponsored by the U.S. Department of Agriculture (the "B&I Loan
Program"). Under the B&I Loan Program, loans are to be originated in rural
areas (generally areas with a population of less than 50,000) and are partially
guaranteed by the U.S. Government. The U.S. Government guarantees


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<PAGE>   6

repayment generally up to 80% of the principal amount of loans originated under
the B&I Loan Program. The Company has not originated any B&I Loan Program loans
to date. While the Company has approved several loans, none have been closed.
The Company still intends to originate loans pursuant to the B&I Loan Program.
Management of the Company does not anticipate a substantial amount of loans to
be originated pursuant to the B&I Loan Program during the year ended December
31, 1999.

NON INVESTMENT COMPANY SUBSIDIARIES

        PMC Capital is either directly or indirectly the sole shareholder or
partner of several non-investment company subsidiaries. These are: PMC
Advisers, Ltd. and its subsidiary ("PMC Advisers"); PMC Funding Corp. and its
subsidiary ("PMC Funding"); PMC Capital Limited Partnership (the "1996
Partnership") and its related general partner and trust; and PMC Capital, L.P.
1998-1 (the "1998 Partnership", and together with the 1996 Partnership, the
"Partnerships") and its related general partner.

        The accompanying consolidated financial statements include the accounts
of PMC and its wholly-owned regulated investment company subsidiaries. The
accounts of PMC Advisers, PMC Funding, and the Partnerships are accounted for
by the equity method of accounting in conformity with the requirements of the
Federal securities laws.

        PMC ADVISERS. PMC Advisers, organized in July 1993, is a registered
investment advisor under the Investment Advisers Act of 1940 which acts (either
directly or through its subsidiary PMC Asset Management, Inc.) as the
investment advisor for PMC Commercial. PMC Advisers provides investment
advisory services to PMC Commercial pursuant to investment management
agreements (the "Investment Management Agreements") entered into between PMC
Capital, PMC Advisers and PMC Commercial. As the investment advisor for PMC
Commercial, PMC Advisers has earned $2,563,000, $1,622,000 and $1,562,000 in
advisory fees during the years ended December 31, 1998, 1997 and 1996,
respectively.

        LIMITED PARTNERSHIPS. The 1996 Partnership was formed as a special
purpose affiliate of the Company. On November 13, 1996, the 1996 Partnership, a
Delaware limited partnership, completed a structured financing (the "1996
Structured Financing") through a private placement (the "1996 Private
Placement") of approximately $40.7 million of its Loan-Backed Fixed Rate Notes,
Series 1996-A (the "1996 Notes"). The 1996 Notes were issued at par and have a
stated maturity in 2011. These notes were issued with an interest rate of
6.725% per annum and were originally collateralized by approximately $45.7
million of loans (the "Initial Loan Contribution") contributed by PMC Capital
to the 1996 Partnership. The net book value of the Initial Loan Contribution
after deferred commitment fees, discounts and accrued interest receivable on
the date of transfer was approximately $45.5 million. In connection with the
1996 Private Placement, the 1996 Notes were given a rating of "Aa2" by Moody's
Investors Service. The terms of the 1996 Notes provide that the partners of the
1996 Partnership are not liable for any payments on the 1996 Notes.
Accordingly, if the 1996 Partnership fails to pay the 1996 Notes, the sole
recourse of the holders of the 1996 Notes is against the assets of the 1996
Partnership. The Company, therefore, has no obligation to pay the 1996 Notes,
nor do the holders of the 1996 Notes have any recourse against the assets of
the Company. The net proceeds from the issuance of the 1996 Notes
(approximately $37.5 million prior to payment of issuance costs of
approximately $396,000 and after the funding of a $2.04 million reserve fund
held by the trustee as collateral) were distributed to PMC Capital. PMC Capital
Corp. was formed in November 1996 to act as the independent trustee of PMC
Trust 1996-A which is the general partner of the 1996 Partnership and owns a 1%
general partnership interest in the 1996 Partnership. PMC Capital owns a 99%
limited partnership interest in the 1996 Partnership. PMC is the servicer for
all loans held by the 1996 Partnership.

        The 1998 Partnership was formed as a special purpose affiliate of the
Company. On November 24, 1998, the 1998 Partnership, a Delaware limited
partnership, completed the 1998 Structured Sale through a private placement
(the "1998 Private Placement") of approximately $39.6 million of its 1998
Loan-Backed Adjustable Rate Notes - Class A, (the "1998 Class A Notes"). The
1998 Class A Notes were issued at par and have a stated maturity in 2021. These
notes were issued with an interest rate of the prime rate less 1%, adjusted on
a quarterly basis and were originally collateralized by approximately $43
million of loans (the "1998 Initial Loan Contribution") contributed by PMC
Capital to the 1998 Partnership. In connection with the 1998 Private Placement,
the 1998 Class A Notes were given a rating of "Aaa" by Moody's Investors
Service. The terms of the 1998 Class A Notes provide that the partners of the
1998 Partnership are not liable for any payments on the 1998 Class A Notes.
Accordingly, if the 1998 Partnership fails to pay the 1998 Class A Notes, the
sole recourse of the holders of the 1998 Class A Notes is against the assets of
the 1998 Partnership. The Company, therefore, has no obligation to pay the 1998
Class A Notes, nor do the holders of the 1998 Class A Notes have any recourse
against the assets of the Company. The net proceeds from the issuance of the
1998


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Class A Notes (approximately $39.8 million prior to payment of issuance costs
of approximately $500,000 and the funding of approximately $2.6 million for a
reserve fund held by the trustee as collateral) were distributed to PMC
Capital. In addition, approximately $2.2 million of the 1998 Partnership's
Loan-Backed Adjustable Rate Notes - Class B, (the "1998 Class B Notes" which
were issued at par, have a stated maturity in 2021 and bear interest at the
prime rate less 0.9% adjusted on a quarterly basis), were purchased by PMC
Capital in the 1998 Private Placement. The 1998 Class B Notes were given a
rating of "A1" by Moody's Investors Service. PMC Capital Corp. 1998-1 was
formed in November 1998 to act as the general partner of the 1998 Partnership
and owns a 1% general partnership interest in the 1998 Partnership. PMC Capital
owns a 99% limited partnership interest in the 1998 Partnership. PMC is the
servicer for all loans held by the 1998 Partnership.

        PMC FUNDING. PMC Funding is a Florida corporation that holds assets on
behalf of the Company. PMC Capital is the sole shareholder of PMC Funding.
Operations from PMC Funding consisted of income generated from the operation of
properties held and charter revenue derived from use by third parties of PMC
Funding's airplane. PMC Funding discontinued the use of its airplane for
charter during 1997 and sold the airplane during February, 1999.

ELECTION TO BE A BUSINESS DEVELOPMENT COMPANY

        In 1994, PMC Capital elected to become a business development company
("BDC") rather than a registered investment company under the 1940 Act. BDCs
must register their shares under the Securities Exchange Act of 1934, as
amended (the "Exchange Act"), and are subject to the Exchange Act's periodic
reporting requirements rather than the 1940 Act's reporting requirements.
Companies having securities registered under the Exchange Act, such as PMC
Capital, must file quarterly rather than semi-annual financial reports. The
1980 Amendment provides BDCs with greater operating flexibility relating to
capital structure, portfolio diversification, transactions with downstream
affiliates, executive stock options and the frequency which they may make
distributions from capital gains, that may be greater than that available to
registered investment companies.

FUNDAMENTAL AND OTHER POLICIES OF THE COMPANY AND ITS SUBSIDIARIES

        PMC Capital and each of its investment company subsidiaries have
designated certain investment policies as "fundamental policies," which may
only be changed with the approval of the holders of PMC Capital's outstanding
shares of Common Stock as described below.

        The following investment policies of PMC Capital and its investment
company subsidiaries are fundamental policies and may not be changed without
the approval of the lesser of (i) more than 50% of PMC Capital's outstanding
voting securities, or (ii) 67% or more of PMC Capital's voting securities
present at a meeting of security holders at which a quorum is present. All
other investment policies of PMC Capital may be changed by its Board of
Directors at any time.

        1. The Company will not purchase or sell commodities or commodity
contracts.

        2. The Company will not engage in short sales, purchase securities on
margin or trade in contracts commonly called puts or calls or in combinations
thereof, except that it may acquire warrants, options or other rights to
subscribe to or sell securities in furtherance of its investment objectives.

        3. The Company will not underwrite securities of other issuers, except
that it may acquire portfolio securities under circumstances where, if sold,
the Company might be deemed an underwriter for purposes of the Securities Act
of 1933. The Company may purchase "restricted securities" as to which there are
substantial restrictions on resale under the Securities Act of 1933.

        4. The Company will not purchase any securities of a company if any of
the directors or officers of the Company owns more than 0.5% of such company
and such persons owning more than 0.5% together own 5% or more of the shares of
such company.

        5. The Company may issue senior securities in the form of debentures,
reverse repurchase agreements and preferred stock and may borrow monies from
banks and other lenders, all on an unsecured basis. The 1940 Act


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<PAGE>   8

limits the Company to the issuance of one class of senior debt securities and
one class of senior equity securities (as such terms are defined in the 1940
Act).

        6. The Company will not invest more than 25% of its total assets in any
one industry except in the lodging industry which may constitute 100% of the
Company's portfolio. The Company will invest at least 25% of its total assets
in the lodging industry.

        7. The Company may invest in real estate development companies, may
make real estate acquisition loans and real estate improvement loans and may
further make other loans secured by real estate.

        8. The Company may make loans and purchase debt securities in
furtherance of its investment objectives. The Company will not make loans to
its officers, directors or other affiliated persons.

        9. PMCIC will perform the functions and conduct the activities
contemplated under the SBIA, and will provide assistance solely to small
business concerns which will contribute to a well-balanced national economy by
facilitating ownership of such concerns by persons whose participation in the
free enterprise system is hampered because of social or economic disadvantages.
These fundamental policies of PMCIC may not be changed without the prior
written consent of the SBA.

        As stated above, the Company has a fundamental policy regarding
investment in the lodging industry. At December 31, 1998 and 1997, loans to
businesses in the lodging industry comprised 61% and 59% of its total assets,
respectively.

        There can be no assurance that the Company will continue to experience
the positive results it has historically achieved from lending to the lodging
industry or that market conditions will enable the Company to maintain or
increase its level of loan concentration in this industry. Any economic factors
that negatively impact this industry could have a material adverse effect on
the business of the Company. Additionally, at December 31, 1998, loans to
businesses located in Texas and California comprised approximately 35% and 8%
of the Company's outstanding loan portfolio, respectively. A decline in
economic conditions in any of these states may adversely affect the Company.

COMPETITION

        The Company's primary competition comes from banks, financial
institutions and other lending companies. Additionally, there are lending
programs which have been established by national franchisors in the lodging
industry. Some of these competitors have greater financial and larger
managerial resources than the Company. Competition has increased as the
financial strength of the banking and thrift industries improved. In
management's opinion, there has been an increasing amount of competitive
lending activity at advance rates and interest rates which are considerably
more aggressive than those offered by the Company. In order to maintain a
quality portfolio, the Company will continue to adhere to its historical
underwriting criteria, and as a result, certain loan origination opportunities
will not be funded by the Company. The Company believes that it competes
effectively with such entities on the basis of the lending programs offered,
the interest rates, maturities and payment schedules, the quality of its
service, its reputation as a lender, the timely credit analysis and decision
making processes, and the renewal options available to borrowers. In addition,
to the extent the investment opportunities reviewed by PMC Advisers conform to
the investment criteria of PMC Commercial, and PMC Commercial has funds
available to make these investments, such investments will be made by PMC
Commercial.

LEVERAGE

        The Company has borrowed funds and issued shares of preferred stock,
and intends to borrow additional funds through advances on its revolving credit
facility and through the issuance of notes payable or SBA debentures, if
available, see "Overview of SBA Regulations." As a result, the Company is
leveraged. The SBA and private lenders have fixed dollar claims on the
Company's assets superior to the claims of the holders of Common Stock. Any
increase in the interest rate earned by the Company on investments in excess of
the interest rate or dividend payable on the funds obtained from either
borrowings or the issuance of preferred stock would cause its net income and
earnings per share to increase more than it would without leverage, while any
decrease in the interest rate earned by the Company on investments would cause
net income and earnings per share to decline by a greater amount than it would
without


                                       6
<PAGE>   9

leverage. Leverage is thus generally considered a speculative investment
technique. In order for the Company to repay indebtedness or meet its
obligations in respect of any outstanding preferred stock on a timely basis,
the Company may be required to dispose of assets at a time which it would not
otherwise do so and at prices which may be below the net book value of such
assets. Dispositions of assets may adversely impact the Company's results of
operations.

INTEREST RATE AND PREPAYMENT RISK

        As a result of the general downward trend in interest rates, the
Company has experienced an increase in the number and the dollar amount of
loans prepaid. On prepayments of fixed-rate loans, the Company received the
immediate benefit of the prepayment charge; however, the proceeds from the
prepayments were invested initially in temporary investments and have been
reloaned or committed to be reloaned at lower rates. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations". The
impact of the lower lending rates is partially offset (based on current market
conditions) by the reduced cost of the Company's borrowings.

        Net income of the Company is affected by the spread between the rate at
which it borrows funds and the rate at which it loans these funds. PMC Capital,
Western Financial and PMCIC have originated both variable and fixed interest
rate loans and the borrowed funds of these companies are typically long-term
and at fixed interest rates. The variable-rate loans in the portfolios of PMC,
PMCIC and Western Financial have been originated under the Prime Lending
Program. Substantially all of the variable-rate loans originated under the
Prime Lending Program were sold in the 1998 Structured Sale. As a result, the
portfolios of PMC, PMCIC, and Western Financial consist primarily of fixed-rate
loans as of December 31, 1998. First Western originates variable-rate loans and
has utilized both advances from PMC Capital and the structured sale of its
portfolio (transactions were completed in 1994 and 1997) to obtain funds
necessary to originate loans. If the yield on loans originated by the Company
with funds obtained from borrowings or the issuance of preferred stock, if any,
fails to cover the cost of such funds, the Company's cash flow will be reduced.
During periods of changing interest rates, interest rate mismatches on loans
not securitized could negatively impact the Company's net income, dividend
yield and the market price of the Common Stock. Generally, the fixed-rate loans
that the Company originates have prepayment penalties. If interest rates
decline, the Company may experience significant prepayments. Such prepayments,
as well as scheduled repayments, are likely to be reloaned or invested at lower
rates, which may have an adverse effect on the Company's ability to maintain
dividend distributions at existing levels. First Western's loans (all variable
interest rate) do not have prepayment penalties in accordance with SBA policy.

SECURITIZATION AND STRUCTURED FINANCING PROGRAMS

        The Company has relied upon its ability to utilize portions of its loan
portfolio in the asset-backed securities market to generate cash proceeds for
funding additional loans. Further, gains on sales generated by the Company's
"securitizations" represent a material portion of the Company's revenues. Such
gains may cause timing differences between net income in accordance with
generally accepted accounting principles ("GAAP") and investment company
taxable income. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations - Dividends". Any delay in the sale of
receivables beyond a quarter-end or year-end would eliminate the gain on sale
in the given quarter or year and adversely affect the Company's reported
earnings for such quarter or year. Any such adverse changes or delays could
have a material adverse effect on the Company's financial position, liquidity
and results of operations. Accordingly, adverse changes in the Company's
"Asset-Backed Securities Program" or in the asset-backed securities market for
the type of product generated by the Company could adversely affect the
Company's ability to originate and securitize loans on a timely basis and upon
terms favorable to the Company. During the latter half of 1998, the liquidity
of the asset-backed securities market was significantly impacted by several
factors. Several publications identified the ongoing global financial crisis in
overseas currencies coupled with the potential for a recession in the United
States as a cause for investors in the type of asset-backed securities placed
by the Company to widen the "spreads" they require to receive in order to
purchase asset-backed securities. Accordingly, the 1998 Private Placement was
completed under less than ideal market conditions and the interest rate payable
on the 1998 Class A Notes was negatively impacted by market conditions. As a
result, the Company recognized less profit on the transfer of the loans in
November 1998 to the 1998 Partnership than would have been attainable in
previous quarters.

        The Company retains a substantial portion of the default and prepayment
risk associated with the loan portfolio that it sells pursuant to the
Asset-Backed Securities Program. A large component of the gain recognized on
such sales and the corresponding asset recorded on the Company's balance sheet
is an interest-only strip receivable the value of


                                       7
<PAGE>   10

which is based on the present value of estimated future excess cash flows which
will be received by the Company from the securitized loans. Accordingly, the
value of the interest-only strip receivable is calculated on the basis of
management's assumptions concerning, among other things, defaults and
prepayments. Actual defaults and prepayments may vary from management's
assumptions, possibly to a material degree.

        Greater than anticipated prepayments of principal will decrease the
fair value attributed to the interest-only strip receivable. Fewer than
anticipated prepayments of principal will increase the fair value attributed to
the interest-only strip receivable. The effect on the Company's yield due to
principal prepayments on the underlying securitized loans occurring at a rate
that is faster (or slower) than the rate anticipated by the Company in the
period immediately following the completion of the securitization will not be
entirely offset by a subsequent like reduction (or increase) in the rate of
principal payments. The weighted average lives of the underlying securitized
loans will also be affected by the amount and timing of delinquencies and
defaults on the underlying securitized loans and the recoveries, if any, on
defaulted underlying securitized loans. In addition, the Company is required to
deposit substantial amounts of the cash flows generated by its interests in the
Company sponsored securitizations ("restricted cash") into spread accounts
which are pledged to the security holders.

        The Company regularly measures its default, prepayment and other
assumptions against the actual performance of securitized receivables including
the guaranteed portion of loans sold. If the Company were to determine, as a
result of such regular review or otherwise, that it underestimated (or
overestimated) defaults and/or prepayments, or that any other material
assumptions were inaccurate, the Company would be required to adjust the
carrying value of its interest-only strip receivable by making a charge to
income and adjusting the carrying value of the interest-only strip receivable
on its balance sheet. An impairment of the interest-only strip receivable (i.e.
reduction of estimated future cash flows) and the corresponding decreases in
earnings and cash flow could affect the Company's ability to service debt and
effect future securitizations and other financings. During 1997, as a result of
increased prepayment speeds, the Company recorded an unrealized loss of
$300,000 on its interest-only strip receivables. During 1998, the continued
high rate of prepayment speeds was more than offset by better than anticipated
loss rates on the portfolios. As a result, during the year ended December 31,
1998 the Company recorded a net unrealized gain and corresponding reduction in
the valuation allowance of $120,000 on the interest-only strip receivables. The
net unrealized loss on the interest-only strip receivables were $180,000 and
$300,000 at December 31, 1998 and 1997, respectively. Although the Company
believes that it has made reasonable assumptions as to the future cash flows of
the various pools of loans that have been sold in securitization transactions,
actual rates of default or prepayment may differ from those assumed and other
assumptions may be required to be revised upon future events. Generally, the
form of credit enhancement agreement entered into in connection with
securitization transactions contains specified limits on the delinquency,
default and loss rates on the receivables included in each issuing entity. If,
at any measurement date, the delinquency, default or loss rate with respect to
any trust were to exceed the specified limits, provisions of the credit
enhancement agreement would automatically increase the level of credit
enhancement requirements for that trust. During the period in which the
specified delinquency, default or loss rate was exceeded, excess cash flow, if
any, from the trust would be used to fund the increased credit enhancement
levels instead of being distributed to the Company, which would have an adverse
effect on the Company's cash flow.

EMPLOYEES

        At December 31, 1998, the Company had 53 employees. Management of the
Company believes its relationship with its employees is good.

OVERVIEW OF SBA REGULATIONS

        The lending operations of First Western, PMCIC and Western Financial
are regulated by the SBA, which establishes, among other things, maximum
interest rates that borrowers may be charged (which currently for PMCIC and
Western Financial may not exceed the greater of 19% per annum or 11% above the
Company's cost of funds from the SBA) and minimum and maximum maturities for
the Company's loans (which generally range from 4 to 25 years). Borrowers must
satisfy certain criteria established by the SBA to qualify for loans originated
by the Company under SBA sponsored programs, including limitations on the net
worth and net income of potential borrowers or alternative criteria that focus
upon the number of employees of the borrower and its gross revenues. In
addition, the SBA generally limits the aggregate amount of guaranties that can
be provided to any single borrower and restricts the use to which the loan
proceeds can be employed by the borrower.


                                       8
<PAGE>   11

        As part of the legislation by Congress in 1996, several increased costs
were put into effect for new SBA debentures. A flat 3% "draw-down" fee replaced
the 2% commitment fee and interest rates charged on newly issued SBA Debentures
increased by 100 basis points. The interest rates previously charged on SBA
debentures were approximately 70 basis points over the 10 year Treasury Note.
As adjusted for fees, the present rates on newly issued SBA debentures would be
approximately 170 basis points over the 10 year Treasury Note. As part of this
legislation, the availability of 3% subsidized debentures and the right of the
SBA to purchase preferred stock of an SSBIC was repealed. This legislative
change has no effect on previously issued debentures or preferred stock of
SSBICs including PMCIC.

        While the eligibility requirements of the SBA 7(a) Program vary by the
industry of the borrower and other factors, the general eligibility
requirements are that: (i) gross sales of the borrower cannot exceed $5.0
million (other than with respect to certain industries where eligibility is
determined based on a number of employees), (ii) liquid assets or real estate
equity of the borrower (and certain affiliates) cannot exceed certain limits
and (iii) the maximum aggregate SBA loan guarantees to a borrower cannot exceed
$750,000. SBA 7(a) Program lenders are required to pay a fee of between 40
basis points and 50 basis points ("SBA Servicing Fees") per annum on the
outstanding principal balance of any loans sold in the secondary market
depending upon when the loan was sold. At present, a 50 basis point fee is in
effect for loans originated after October 1995.

ITEM 2. PROPERTIES

        The Company's headquarters are located at 18111 Preston Road, Suite
600, Dallas, Texas 75252. The Company leases its approximately 13,000 square
foot facility pursuant to a five year lease which commenced in December 1998.
In addition, at December 31, 1998, the Company also leased office space in
Phoenix, Arizona and Atlanta, Georgia. The aggregate annual lease payments for
the year ended December 31, 1998 were approximately $244,000.

ITEM 3. LEGAL PROCEEDINGS

        The Company is involved from time to time in routine litigation
incidental to its business. The Company does not believe that the current
proceedings will have a material adverse effect on the results of operations or
financial condition of the Company.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

        No matters were submitted to a vote of shareholders during the last
quarter of the year ended December 31, 1998.




                                       9
<PAGE>   12

                                    PART II


ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED SHAREHOLDER
        MATTERS

        The Common Stock is traded on the American Stock Exchange ("AMEX") under
the symbol "PMC." The following table sets forth, for the periods indicated,
the high and low sales prices as reported on the AMEX and the dividends per
share declared by the Company for each such period.

<TABLE>
<CAPTION>
                                                                      Regular         Special
                                                                     Dividends       Dividends
                                                                        Per             Per
Quarter Ended                               High          Low          Share           Share
-------------                              ------        ------      ---------       ---------
<S>                                        <C>           <C>           <C>           <C>
December 31, 1998 ......................   $11.00        $ 8.00        $0.250          --
September 30, 1998 .....................   $13.75        $ 9.00        $0.325          --
June 30, 1998 ..........................   $14.38        $13.56        $0.325          --
March 31, 1998 .........................   $15.00        $13.75        $0.325          --

December 31, 1997 ......................   $15.25        $14.00        $0.320        $0.020
September 30, 1997 .....................   $15.50        $13.75        $0.315          --
June 30, 1997 ..........................   $14.88        $12.50        $0.310          --
March 31, 1997 .........................   $14.50        $13.38        $0.305          --

December 31, 1996 ......................   $14.75        $12.88        $0.300        $0.020
September 30, 1996 .....................   $14.25        $11.75        $0.295          --
June 30, 1996 ..........................   $13.38        $12.38        $0.280          --
March 31, 1996 .........................   $13.63        $11.88        $0.270          --
</TABLE>


        On February 26, 1999, there were approximately 1,600 shareholders of
record of Common Stock and the last reported sales price of the Common Stock
was $8.94 per share.


                                      10
<PAGE>   13

ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA

        The following is a summary of Selected Consolidated Financial Data of
the Company as of and for the five years in the period ended December 31, 1998.
The following data should be read in conjunction with the consolidated
financial statements of the Company and the notes thereto and "Management's
Discussion and Analysis of the Financial Condition and Results of Operations"
appearing elsewhere in this Form 10-K. The selected consolidated financial data
presented below has been derived from the consolidated financial statements of
the Company, audited by PricewaterhouseCoopers LLP., independent public
accountants, whose report with respect thereto is included elsewhere in this
Form 10-K.

<TABLE>
<CAPTION>
                                                                           Years Ended December 31,
                                              ----------------------------------------------------------------------------------
                                                 1998              1997              1996              1995              1994
                                              ----------        ----------        ----------        ----------        ----------
                                                                 (In thousands, except per share information)

<S>                                           <C>               <C>               <C>               <C>               <C>       
Operating:

    Operating income ......................   $   24,314        $   24,406        $   23,821        $   21,262        $   16,450

    Operating expenses ....................   $  (11,091)       $  (10,602)       $  (10,454)       $   (9,541)       $   (7,578)

    Realized and unrealized gain (loss)
       on investments .....................   $      726        $    1,818        $     (147)       $     (359)       $    3,151

    Net Operating Income and realized
       and unrealized gain (loss)
       on investments .....................   $   13,949        $   15,622        $   13,220        $   11,362        $   12,023

    Dividends declared, common ............   $   14,473        $   14,543        $   12,853        $   11,600        $   11,244

    Basic and diluted earnings per
        common share ......................   $     1.16        $     1.35        $     1.18        $     1.03        $     1.12

    Dividends per common share ............   $     1.23        $     1.27        $     1.16        $     1.08        $     1.06

    Weighted average common shares
        outstanding .......................       11,800            11,411            11,002            10,768            10,650

    Loans funded ..........................   $   66,450        $   86,361        $   70,154        $   77,567        $   75,349

At end of period:

    Loans receivable, net .................   $  116,711        $  127,240        $   93,354        $  110,499        $   75,264

    Total assets ..........................   $  163,349        $  165,839        $  163,431        $  159,002        $  125,416

    SBA debentures payable ................   $   39,790        $   41,290        $   44,570        $   43,540        $   26,280

    Notes payable .........................   $   35,000        $   35,000        $   35,000        $   35,001        $   25,001

    Preferred stock of consolidated
        subsidiary ........................   $    7,000        $    7,000        $    7,000        $    7,000        $    5,000

    Common shareholders' equity ...........   $   72,151        $   70,166        $   62,903        $   59,088        $   57,371

    Number of common shares
        outstanding .......................       11,829            11,631            11,162            10,871            10,684

Ratios:

    Return on average assets ..............          8.5%              9.7%              8.3%              8.0%             10.3%

    Return on common shareholders'
        equity ............................         19.2%             23.3%             21.3%             19.2%             21.2%
</TABLE>


                                      11
<PAGE>   14

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
        OF OPERATIONS

RESULTS OF OPERATIONS

GENERAL

The Company's operations include originating and servicing commercial loans for
its own account. In addition, the Company operates as an investment manager to
evaluate properties and loans and to service loans and lease contracts pursuant
to a fee arrangement for PMC Commercial. The Company sells the government
guaranteed portion of its loans originated under the SBA 7(a) Program. Further,
the Company has completed several structured sales of its loan portfolio.
Historically, the Company has retained servicing and residual interests in all
loans sold.

        The Company's revenue sources include the following:

        o       Interest earned on commercial loans originated and retained
                including the effect of commitment fees collected at the
                inception of the loan.
        o       Fee income from the management of PMC Commercial.
        o       An equity interest in the income of non-investment company
                subsidiaries.
        o       Premiums recognized from the sale of the government guaranteed
                portion of SBA 7(a) Program loans into the secondary market
        o       Interest earned on temporary (short-term) investments.
        o       Other fees, including: late fees, prepayment fees, construction
                monitoring and site visit fees.

        The following table sets forth information concerning the aggregate
gross loans funded by the Company:

<TABLE>
<CAPTION>
                                                      Years Ended December 31,
                            ----------------------------------------------------------------------------
                                    1998                        1997                       1996
                            ---------------------      ----------------------      ---------------------
                                                          (In millions)

                                        Increase                    Increase                   Increase
                            Funded     (decrease)      Funded      (decrease)      Funded     (decrease)
                            ------     ----------      ------      ----------      ------     ----------
<S>                         <C>           <C>          <C>             <C>         <C>            <C> 
PMCIC ...................   $ 14.1        (41)%        $ 24.1          25%         $ 19.3         (9)%
Western Financial .......     12.0         (7)%          12.9          72%            7.5         (6)%
First Western ...........     10.6        (64)%          29.5           1%           29.2        (28)%
PMC .....................     29.7         49%           19.9          40%           14.2         84%
                            ------                     ------                      ------
                            $ 66.4        (23)%        $ 86.4          23%         $ 70.2         (9)%
                            ======                     ======                      ======
</TABLE>

        During the years ended December 31, 1998 and 1997, the Company funded
$66.4 million and $86.4 million in loans, respectively. The decrease of $20.0
million was primarily related to a decrease in lending by First Western of
approximately $19 million. In addition, PMC, PMCIC, and Western Financial
predominately funded fixed-rate originations during 1998 as compared to a
predominance of variable-rate loan originations during 1997.

        PMC Advisers, either directly or through its wholly-owned subsidiary,
has acted as the investment manager for PMC Commercial since PMC Commercial's
initial public offering in December 1993. During the years ended December
31,1998 and 1997, PMC Advisers and its wholly-owned subsidiary earned
management fees from PMC Commercial of approximately $2.6 million and $1.6
million, respectively. The fees during the year ended December 31, 1998 include
fees earned related to the structured financing and property acquisitions by
PMC Commercial. The fee of PMC Advisers is primarily based on the amount and
value of assets. As a result, any increases in the dollar amount of PMC
Commercial's assets will benefit PMC Advisers, and PMC Advisers will have a
potential conflict in determining whether to advise PMC Commercial to acquire
assets and write down the value of any assets. In order to mitigate the risk to
PMC Commercial from increasing its asset base through leveraged transactions,
the Investment Management Agreements provide PMC Advisers 


                                      12
<PAGE>   15

with a reduced fee for any loans originated through additional borrowings.
Additionally, the potential conflict for the management of PMC Advisers between
PMC Commercial and the Company is mitigated through the Loan Origination
Agreement described above.

        Pursuant to the Investment Management Agreements between PMC Commercial
and PMC Advisers, fees of between 0.875% and 1.67%, annually, are charged by
the Company based upon the average principal outstanding of the Company's
loans. In addition, during 1996 the Investment Management Agreement was amended
to include compensation to PMC Advisers for its assistance in the issuance of
PMC Commercial's debt and equity securities. During June 1998, the investment
management agreement was amended to provide for payment of fees relating to
property acquisitions by PMC Commercial (the "Property Management Agreement").
The Property Management Agreement provided for a one time fee of 0.75% of the
purchase price paid by PMC Commercial to Amerihost Properties, Inc. and its
subsidiaries ("Amerihost") (the "Amerihost Purchase Price") in connection with
the purchase of hotels from Amerihost and an annual management fee equal to the
product of 0.70% multiplied by the Amerihost Purchase Price (the "Amerihost
Fee"). In the event the Property Management Agreement with PMC Advisers is
terminated or not renewed by PMC Commercial (other than as a result of a
material breach by PMC Advisers) or by PMC Advisers (as a result of a material
breach by PMC Commercial), PMC Advisers would be entitled to receive the
Amerihost Fee for a period of five years from the termination date.

        The Company also earns income through its equity ownership in the
unconsolidated subsidiaries, primarily the 1996 Partnership. The differential
between the interest received by the 1996 Partnership on the loans transferred
to it by PMC Capital and the interest paid by the 1996 Partnership on the 1996
Notes, less any loan losses and amortization of transaction fees, contributes
to the revenues of PMC Capital through its equity ownership in the 1996
Partnership.

        As a result of several factors, the number and dollar volume of loans
originated by First Western under the SBA SBA 7(a) Program have decreased. The
factors which contributed to this decrease included an increase in guarantee
fees due to the SBA by the borrower under the SBA 7(a) Program, increased
competition for SBA 7(a) Program loans, and an increase in competition from
alternative loan products. These other products often provide prospective
borrowers with fixed interest rates at less than the floating interest rates
available through the SBA 7(a) Program. Accordingly, SBA 7(a) Program funding
has decreased and the premiums earned on the sales of the government guaranteed
portions of these loan have been significantly reduced. For the years ended
December 31, 1998 and 1997, revenues generated by such loan sales were $776,000
and $1,776,000, respectively. Because of the above factors and an increase in
the number of borrowers requesting fixed-rate financing, the Company believes
that revenues generated from the sales of the guaranteed portion of the SBA 7
(a) Program loans will continue at present levels or may possibly diminish in
the foreseeable future. The Company has attempted to offset First Western's
decreased revenues through emphasizing the Company's other lending activities
and offering lower fixed interest rates.

        As a result of the general downward trend in interest rates, the
Company has experienced an increased rate in the prepayment of its loans.
During the years ended December 31, 1998 and 1997, the Company received $24.7
million and $10.1 million, respectively, in collections of principal on
retained loans including prepayments. For the years ended December 31, 1998 and
1997, principal collections including prepayments (as an annualized percentage
of the Company's total retained loan portfolio), were 19% and 11%,
respectively. Prepayments generally increase during times of declining interest
rates. On such prepayments, to the extent the loans were at a fixed-rate of
interest, the Company received the immediate benefit of the prepayment charge.
Prepayment fees result in one-time increases in the Company's other income.
However, the proceeds from the prepayments were invested initially in temporary
investments and have been re-loaned or committed to be re-loaned at lower rates
which has an adverse effect on the Company's future results of operations and
dependant upon the rate of future prepayments may have an impact on the
Company's ability to maintain shareholder's distributions at current levels.
The impact of the lower lending rates may partially be offset (based on current
market conditions) by the reduced cost of the Company's borrowings on
subsequent leverage. First Western's loans (all variable-rate) have no
prepayment fees in accordance with SBA policy. Loans originated pursuant to the
Prime Lending Program generally have prepayment fees equal to 95 days'
interest. The Company believes that the prepayments may continue at accelerated
levels in the near term. As a result of recent changes in the credit markets,
the pace of prepayment activity may decrease later in the current fiscal year.
See "Prepayment Risk".

        Substantially all of the First Western loans and all loans originated
pursuant to the Prime Lending Program (described below) are variable rate which
reset quarterly based on a spread above the prime rate of interest as stated in
The Wall Street Journal on the first day of the applicable period ("Prime
Rate"). The spread over the Prime Rate charged by First Western ranges from
1.0% to 2.75% and the weighted average spread over the Prime Rate for the Prime
Lending Program is approximately 1.3%.


                                      13
<PAGE>   16

        The Prime Rates utilized for variable-rate loans were as follows:

<TABLE>
<CAPTION>
                                    1998            1997            1996
                                   ------          ------          ------ 
<S>                                 <C>             <C>             <C>  
     First Quarter                  8.50%           8.25%           8.50%
     Second Quarter                 8.50%           8.50%           8.25%
     Third Quarter                  8.50%           8.50%           8.25%
     Fourth Quarter                 8.25%           8.50%           8.25%
</TABLE>

        Late in the fourth quarter of 1996 the Company began marketing a
variable interest rate lending program based on the Prime Rate (the "Prime
Lending Program") which is separate from the SBA 7(a) Program of First Western,
the Company's other variable rate lending program. The Prime Lending Program
provides funds to refinance existing real estate secured commercial loans with
borrowers who have proven timely payment histories and loan-to-value and debt
coverage ratios within the Company's underwriting criteria. Several of the
loans refinanced under this program were originally SBA 7(a) Program loans and
some of these loan originations have refinanced First Western's loans.

        The Company's working capital requirements for loan originations, as
well as holding borrowers advances and cash reserves for its completed
securitizations or structured financings, require it to maintain temporary
short-term investments. In order to minimize its short-term investment
positions, the Company may establish a bank warehouse facility and expects to
more fully utilize its revolving credit facility to fund these working capital
requirements.

        The Company receives other investment income from various sources
including late fees, prepayment fees, construction monitoring fees and site
visit fees. The net amount of other investment income earned during the years
ended December 31, 1998 and 1997 was $807,000 and $504,000, respectively. The
amount earned will vary based on volume of loans funded, the timing and amount
of financings, volume of loans which prepay, the mix of loans (construction
versus non-construction), the rate and type of loans originated (whether fixed
or variable) as well as the general level of interest rates.

        Expenses primarily consist of interest expense and company overhead.
Expenses were 46% and 43% of total income during the years ended December 31,
1998 and 1997, respectively. The Company's operations are centralized in its
Dallas, Texas headquarters. The Company presently has additional business
development offices located in Atlanta, Georgia and Phoenix, Arizona.

        General and administrative expenditures consist primarily of insurance,
advertising and promotional expense, telephone services, corporate printing
costs and general office expenses. General and administrative expenses were 3%
of total income during both the years ended December 31, 1998 and 1997. It is
anticipated that general and administrative expenses will maintain at present
levels during the year ending December 31, 1999.

        Profit sharing plan, rent, legal and accounting, SBA fees and directors
and shareholders expense (collectively the "Other Administrative Costs")
aggregated $838,000 and $822,000 during the years ended December 31, 1998 and
1997, respectively. The Other Administrative Costs were 3% of total income
during both the years ended December 31, 1998 and 1997. It is anticipated that
Other Administrative Costs will maintain at present levels during the year
ending December 31, 1999.

CERTAIN ACCOUNTING CONSIDERATIONS

        Effective January 1, 1997, the Company adopted as required, SFAS No.
125, "Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities." SFAS No. 125 provides for the accounting and
reporting of transfers and servicing of financial assets based on a
financial-components approach.

        The transfer of assets that qualifies for sale treatment under SFAS No.
125 is generally accounted for by the seller by: (i) derecognizing all assets
sold, (ii) recognizing all assets obtained and liabilities incurred at their
relative fair value, and (iii) recognizing all assets retained at their
allocated previous carrying amount based on relative fair values. The Company
typically receives cash and retains the right to receive contractual servicing
fees and the right to receive future interest income on loans sold that exceed
the contractually specified servicing fee (the interest-only strip receivable)
in exchange for a portion of the loan, typically the guaranteed portion of an
SBA 7(a) loan. The difference between (i) the carrying value of the portion of
loans sold and (ii) the sum of (a) cash received, (b) the relative fair values
of the servicing rights, and (c) the interest-only strip receivable retained,
constitutes the gain on sale.


                                      14
<PAGE>   17

        In accordance with SFAS No. 125, the Company establishes a servicing
asset to the extent the Company receives contractual compensation for servicing
loans which is in excess of the cost of servicing these loans. Servicing the
sold portion of government guaranteed loans requires First Western to retain a
minimum servicing spread of 1%. This spread is in excess of the costs
associated with servicing these loans. Accordingly, the Company has recorded a
servicing asset relating to the servicing of the sold portion of First
Western's loans. The servicing asset is amortized in proportion to and over the
period of estimated net servicing income and is evaluated for impairment by
stratifying the servicing assets by one or more of the predominant risk
characteristics of the underlying financial assets.

        The interest-only strip receivable is accounted for as an investment in
debt securities classified as available for sale under SFAS No. 115. As of the
date a securitization is completed, an asset is established and classified as
an "interest-only strip receivable". This receivable is initially valued based
on management's estimate of the anticipated discounted future cash flows
retained by the Company related to the pool of securitized loans. The discount
rate is a market rate based on interest rate levels at the time of completion
of the transaction considering the risks inherent in the transaction.

        On a quarterly basis thereafter, income generated by the interest-only
strip receivable is recognized based on an "internal rate of return" (the
"IRR") which during the initial reporting period after completion of the
securitization is the market rate used in valuing the interest-only strip
receivable. Management updates the anticipated future cash flows on a quarterly
basis and determines a revised IRR based on the recorded interest-only strip
receivable as of the balance sheet date. If during any evaluation of the value
of the interest-only strip receivable it is determined that the IRR is lower
than a "risk free" rate for an asset of similar duration, a realized loss will
be incurred which adjusts the recorded value of the interest-only strip
receivable to the market value.

        In addition, on a quarterly basis, the Company measures the fair value
of the interest-only strip receivable based upon the future anticipated cash
flows discounted to reflect the current market interest rates for investments
of this type. Any appreciation (depreciation) of the interest-only strip
receivable is reflected on the accompanying consolidated statements of income
as an unrealized gain (loss) on investments. During the years ended December
31, 1998 and 1997, the Company recorded a net unrealized gain of $120,000 and a
net unrealized loss of $300,000, respectively, related to the interest-only
strip receivables. At December 31, 1998 and 1997, an unrealized loss was
recorded on the interest-only strip receivable of $180,000 and $300,000,
respectively.

        The estimated net servicing income and the investment in the
interest-only strip receivable are based in part upon management's estimate of
prepayment speeds, including default rates. There can be no assurance of the
accuracy of these estimates. If the prepayment speeds occur at a faster rate
than anticipated, the amortization of the servicing asset will be accelerated
and the value of the interest-only strip receivable will decline. If
prepayments occur slower than anticipated, cash flows would exceed estimated
amounts and total income in future periods would be enhanced. During the years
ended December 31, 1998 and 1997, the amount of amortization of the servicing
asset was increased as a result of increased prepayment speeds. See -
Securitization and Structured Financing Programs.

YEAR ENDED DECEMBER 31, 1998 COMPARED TO THE YEAR ENDED DECEMBER 31, 1997

        Net income decreased by $1,673,000 from $15,622,000 during the year
ended December 31, 1997 to $13,949,000 during the year ended December 31, 1998.
The weighted average common shares outstanding increased by approximately 3%
from 11,411,000 during the year ended December 31, 1997 to 11,800,000 during
the year ended December 31, 1998 as a result of shares issued pursuant to the
dividend reinvestment and cash purchase plan. The most significant reason for
the decline in net income was the reduced amount of income recognized on
structured sales of loan portfolio when comparing the years ended December 31,
1998 and 1997. The income for the year ended December 31, 1998 includes the
effect of the following, as more fully described below: (i) reduced interest
income earned as a result of the sale by First Western of $22.8 million of
loans in December 1997 and a general decline in the interest rate on
outstanding loans, (ii) reduced premium income, (iii) increased investment
management fees, (iv) the gain resulting from the 1998 Structured Sale and (v)
changes in valuation reserves.

        Interest income: Interest income increased by $78,000, from $17,136,000
for the year ended December 31, 1997 to $17,214,000 for the year ended December
31, 1998. Interest income includes the interest earned on loans, the interest
earned on short-term ("temporary") investments, up-front fees collected
including the accretion of up-front fees and the interest earned on Spread
Assets ("Spread Income"). This overall decrease was primarily attributable to a
decrease in interest on temporary investments and the continued decline in
interest rates on new loan originations.

        Interest on short-term investments for the year ended December 31, 1997
was greater than for 1998 due to the fact that the average temporary
investments outstanding during the year ended December 31, 1998 were $13.8
million, a 52% 


                                      15
<PAGE>   18

decrease from $28.9 million during the year ended December 31, 1997. The
average outstanding temporary investments fluctuates based on the size and
timing of receipt of capital resources and the volume of loan originations and
prepayment activities. Accordingly, interest on temporary investments decreased
by $782,000, or 58%, from $1,358,000 during the year ended December 31, 1997 to
$576,000 during the year ended December 31, 1998.

        Interest income on loans increased by $860,000, or 5%, from $15,778,000
during the year ended December 31, 1997 to $16,638,000 during the year ended
December 31, 1998. The increase in interest income was primarily a result of
the increase in outstanding principal on loans. The average retained loan
portfolio increased by 18% to $134.4 million during the year ended December 31,
1998 from $113.8 million during the year ended December 31, 1997. This increase
was partially offset by a continuation of lower interest rates charged on new
loan originations and the prepayment of the higher interest rate loans. As
competition has increased and acceptability of hospitality lending was
increased by loan programs of major investment banks (commonly known as
"conduit" programs), the rate able to be charged by the Company was decreasing
while prepayments were increasing. The proceeds from the prepayments were
invested initially in temporary investments and have been re-loaned at lower
interest rates. As a result, the weighted average interest rates on outstanding
retained loans decreased to 10.0% at December 31, 1998 from 10.5 % at December
31, 1997.

        Premium income: Premium income decreased by $1,000,000 (56%) from
$1,776,000 for the year ended December 31, 1997 to $776,000 for the year ended
December 31, 1998. This decrease was primarily attributable to a $11,660,000
(53%) decrease in the government guaranteed portion of loans held for sale or
sold (under the SBA 7(a) Program) from $21,638,000 during the year ended
December 31, 1997 to $9,978,000 during the year ended December 31, 1998. As a
result of several factors, the number and dollar volume of loans originated by
First Western under the SBA 7(a) Program have decreased. The factors which
contributed to this decrease included an increase in guarantee fees due to the
SBA by the borrower under the SBA 7(a) Program, increased competition for SBA
7(a) Program loans, and an increase in competition from alternative loan
products. These other products often provide prospective borrowers with fixed
interest rates at less than the floating interest rates available through the
SBA 7(a) Program. Accordingly, premiums earned have been significantly reduced.
It is anticipated that future fundings, and sales of the guaranteed portion of
loans, may continue at levels experienced during 1998.

        Other investment income, net: Other investment income, net, increased
by $303,000 (60%) from $504,000 for the year ended December 31, 1997 to
$807,000 for the year ended December 31, 1998. This increase was primarily
attributable to an increase in prepayment fees received and recognition of
discount related to fixed-rate loans which were prepaid in full and forfeited
commitment fees during the year ended December 31, 1998 as compared to the year
ended December 31, 1997.

        Equity in income (loss) of unconsolidated subsidiaries: Equity in
income (loss) of unconsolidated subsidiaries increased by $64,000 (3%), from
$2,560,000 during the year ended December 31, 1997 to $2,624,000 during the
year ended December 31, 1998. The 1996 Partnership had net income of $2,377,000
and $2,608,000 during the years ended December 31, 1998 and 1997, respectively.
The decrease is primarily due to the continued reduction in outstanding
principal balance of loans held by the 1996 Partnership. Accordingly, the
interest earned on the 1996 Partnership assets is decreasing resulting in less
net profits. The loans held by the 1996 Partnership will continue to be reduced
resulting in a decline in profits to the Company in future periods of
operations. The 1996 Partnership profits include all yield generated from the
loans transferred by PMC Capital less the cost of the 1996 Notes issued by the
1996 Partnership. During the year ended December 31, 1998 and 1997, the net
income from the 1996 Partnership included $584,000 and $208,000, respectively,
in prepayment fees received on loans paid-off prior to their contractual
maturity. Also included in equity in income of unconsolidated subsidiaries is
the net income of PMC Advisers and the 1998 Partnership of $179,000 and
$178,000, respectively, during the year ended December 31, 1998 and the
operations of PMC Funding which had losses of $109,000 and $48,000 during the
years ended December 31, 1998 and 1997, respectively.

        Other income, net: Other income, net, increased by $463,000 (19%) from
$2,430,000 during the year ended December 31, 1997 to $2,893,000 during the
year ended December 31, 1998. Other income increased during the year ended
December 31, 1998 primarily due to increased investment management fees
generated by PMC Advisers related to the completion of a structured financing
by PMC Commercial (approximately $167,000) and fees related to the acquisition
by PMC Commercial of the Amerihost hotel properties (approximately $466,000).

        Operating expenses: Operating expenses, not including interest,
increased by $570,000 (11%) from $5,054,000 during the year ended December 31,
1997 to $5,624,000 during the year ended December 31, 1998. This increase was
primarily a result of an increase in salaries and related benefits of $530,000
(15%) from $3,435,000 during the year ended December 31, 1997, to $3,965,000
during the year ended December 31, 1998. The increase in salaries and related
benefits was attributable to a decrease in the salaries and related benefits
which were capitalized during the year ended December 31, 1998 


                                      16
<PAGE>   19

as compared to the year ended December 31, 1997. Operating expenses are
comprised of salaries and related benefits, general and administrative, profit
sharing plan, rent, legal and accounting, SBA fees and director's and
shareholder's expense. The largest operating expense is the salaries and
related benefits which consist of salaries for the Company's officers and
employees who provide all of the Company's management, advisory, and portfolio
functions, including marketing, servicing, accounting and portfolio analysis.
Salaries and related benefits were 16% and 14%, respectively, of total income
during the years ended December 31, 1998 and 1997. It is anticipated that
operating expenses will maintain at present levels during the year ending
December 31, 1999.

        Interest expense: Interest expense decreased by $81,000 (1%) from
$5,548,000 during the year ended December 31, 1997 to $5,467,000 during the
year ended December 31, 1998. Interest expense results primarily from interest
payments made on (i) the Company's $35 million of unsecured notes with a
weighted average interest rate of 7.3% and weighted average remaining maturity
of 2.8 years as of December 31, 1998, and (ii) $39,790,000 of debentures due to
the SBA as a result of borrowings made by the Company's SBIC subsidiaries, with
a weighted average interest rate of approximately 6.6% and weighted average
remaining maturity of 4.3 years as of December 31, 1998. The decrease was
primarily attributable to the repayment at maturity of approximately $2.5
million in SBA debentures during February 1997 and $1.5 million in February
1998.

        Realized and unrealized gain (loss) on investments: Realized and
unrealized gain (loss) on investments decreased from a gain of $1,818,000
during the year ended December 31, 1997 to a gain of $726,000 during the year
ended December 31, 1998. The primary reason for the decrease in gain was the
reduction in the gain on sale of assets (related to the sale of loan pools) by
the Company. The Company recognized a $2,360,000 gain from the sale of First
Western loans in 1997 and a $925,000 gain from the sale of loans to the 1998
Partnership. The gain in 1997 was greater since; (i) in the 1997 sale, the
notes were sold at par and the underlying loans were previously reflected at a
discount of approximately $1.6 million (in accordance with Emerging Issues Task
Force 88-11) while in the 1998 Structured Sale the loans were sold at par and
the underlying loans receivable were previously reflected at par, and (ii) the
1997 sale was at a greater spread between the weighted average interest rate of
the loans receivable and the coupon due to the security holders as compared to
the 1998 Structured Sale.

        During the years ended December 31, 1998 and 1997, the Company recorded
unrealized gains of $120,000 and losses of $300,000, respectively, relating to
the interest-only strip receivables in accordance with SFAS No. 125.
Additionally, net unrealized and realized losses on retained loans receivable
were $319,000 and $242,000 during the years ended December 31, 1998 and 1997,
respectively.

YEAR ENDED DECEMBER 31, 1997 COMPARED TO THE YEAR ENDED DECEMBER 31, 1996

        Net income increased by $2,402,000 from $13,220,000 during the year
ended December 31, 1996 to $15,622,000 during the year ended December 31, 1997.
The weighted average common shares outstanding increased by approximately 4%
from 11,002,000 during the year ended December 31, 1996 to 11,411,000 during
the year ended December 31, 1997 as a result of shares issued pursuant to the
dividend reinvestment and cash purchase plan. The most significant reason for
the increase in net income was the gain recognized on the sale of loan
portfolio during the year ended December 31, 1997.

        Interest income: Interest income decreased by $1,435,000 (8%), from
$18,571,000 for the year ended December 31, 1996 to $17,136,000 for the year
ended December 31, 1997. This decrease was primarily attributable to a
reduction in PMC Capital's loan portfolio resulting from the 1996 Structured
Financing completed during November 1996 and the First Western Securitization
in December 1997 and a reduction in interest rates on loan originations in
1997. The average retained loan portfolio outstanding decreased 9% from $124.9
million during the year ended December 31, 1996 to $113.8 million during the
year ended December 31, 1997. Accordingly, interest income on loans (not
including the 1996 Partnership) decreased by $1,726,000, or 10%, from
$17,504,000 during the year ended December 31, 1996 to $15,778,000 during the
year ended December 31, 1997. Including the interest earned by the 1996
Partnership of $591,000 and $4,662,000 during the years ended December 31, 1996
and 1997, respectively, interest income on loans increased by $2,346,000 (13%)
to $20,441,000 for the year ended December 31, 1997 as compared to $18,095,000
during the year ended December 31, 1996. During the year ended December 31,
1997, the Company earned increased interest on short-term investments due to
the funds received from the Structured Financing and the First Western
Securitization in December 1997. As a result, during the year ended December
31, 1997, average temporary investments outstanding were $28.9 million, a 36%
increase from $21.3 million during the year ended December 31, 1996.
Accordingly, interest on temporary investments increased by $291,000, or 27%,
from $1,067,000 during the year ended December 31, 1996 to $1,358,000 during
the year ended December 31, 1997.


                                      17
<PAGE>   20

        Premium income: Premium income decreased by $166,000 (9%), from
$1,942,000 for the year ended December 31, 1996 to $1,776,000 for the year
ended December 31, 1997. This decrease was primarily attributable to lower
premium percentages paid for the loans sold during the year ended December 31,
1997 as compared to December 31, 1996. The primary reason for the lower premium
percentages is that the spread above Prime for loans originated and sold was
lower in 1997 than 1996. When the lower interest rate loans are sold, the
percentage premium paid is usually less, accordingly, the income recognized
from loan sales decreased even though the loans sold increased from $20.0
million during the year ended December 31, 1996 to $21.6 million during the
year ended December 31, 1997.

        Other investment income, net: Other investment income, net, decreased
by $104,000 (17%), from $608,000 for the year ended December 31, 1996 to
$504,000 for the year ended December 31, 1997. This decrease was primarily
attributable to a decrease in prepayment fees on the fixed-rate loan portfolio
received during the year ended December 31, 1997 as compared to the year ended
December 31, 1996.

        Equity in income (loss) of unconsolidated subsidiaries: Equity in
income (loss) of unconsolidated subsidiaries increased by $2,191,000, from
income, net, of $369,000 during the year ended December 31, 1996 to income,
net, of $2,560,000 during the year ended December 31, 1997. The increase is
primarily due to the formation of the 1996 Partnership in November 1996 which
had net profits of $2,608,000 during the year ended December 31, 1997 compared
to $328,000 during the year ended December 31, 1996. The 1996 Partnership
profits include all yield generated from the loans contributed by PMC Capital
less the cost of the Notes issued by the 1996 Partnership. Offsetting a portion
of the Partnership income were the operations of PMC Funding which had a
decrease in revenues from charter services of its airplane which resulted in a
reduction in profits from a net income of $41,000 during the year ended
December 31, 1996 to a net loss of $48,000 during the year ended December 31,
1997.

        Other income, net: Other income, net, increased by $99,000 (4%), from
$2,331,000 during the year ended December 31, 1996 to $2,430,000 during the
year ended December 31, 1997. This increase was primarily a result of an
increase in advisory fees. This increase was realized even though a $251,000
fee was generated by PMC Advisers during the year ended December 31, 1996
related to an equity offering of PMC Commercial for which there was no
comparable transaction in 1997.

        Operating expenses: Operating expenses, not including interest,
increased by $308,000 (6%), from $4,746,000 during the year ended December 31,
1996 to $5,054,000 during the year ended December 31, 1997. This increase was a
result of an increase in salaries and related benefits of 255,000 (8%), from
$3,180,000 during the year ended December 31, 1996, to $3,435,000 during the
year ended December 31, 1997. The increase in salaries and related benefits was
attributable to an increased number of employees (due to the increase in
portfolio under management, the complexity of the financing transactions
undertaken by the Company and an increase in marketing personnel), and a
general increase in the level of salaries for employees during 1996 and 1997.
Rent expense increased by $16,000 (8%) during the year ended December 31, 1997
as compared to the year ended December 31, 1996 due to the opening of a new
office during 1997 (Phoenix, Arizona) and the expansion of the Company's space
occupied and an increase in the base rent at its headquarters. Legal and
accounting increased by $43,000 (29%) during the year ended December 31, 1997
as compared to the year ended December 31, 1996 due to the increased cost of
the annual audit (primarily attributable to the formation of the Partnership)
and increases in general corporate legal services. General and administrative
costs decreased by $46,000 during the year ended December 31, 1997 as compared
to the year ended December 31, 1996 due to reductions in state franchise taxes.

        Interest expense decreased by $160,000 (3%), from $5,708,000 during the
year ended December 31, 1996 to $5,548,000 during the year ended December 31,
1997. The decrease was primarily attributable to the repayment at maturity of
approximately $2.5 million and $1.0 million in SBA debentures during February
1997 and September 1997, respectively.

        Realized and unrealized gain (loss) on investments: Realized and
unrealized gain (loss) on investments (not including the sale of assets)
changed from a loss of $147,000 during the year ended December 31, 1996 to a
loss of $542,000 during the year ended December 31, 1997. The period ended
December 31, 1997 includes the effect of the $300,000 unrealized loss related
to the interest-only strip receivables. During both periods, loan losses were
minimal. During the year ended December 31, 1996, the Company recognized
$35,000 in recoveries from previously written-off loans which reduced the net
loss during the period. There were no comparable recoveries during the year
ended December 31, 1997. During the year ended December 31, 1997, the Company
recognized approximately $100,000 in reversal of reserves on loans that paid in
full or have become amortizing loans and the likelihood of collection has
significantly increased which reduced the net loss during the period. There
were no comparable adjustments during the year ended December 31, 1996.


                                      18
<PAGE>   21

CASH FLOW ANALYSIS

        The Company generated $12,052,000 and $10,581,000 from operating
activities during the years ended December 31, 1998 and 1997, respectively. The
primary source of the Company's funds are from net income. The source of funds
from net income is adjusted primarily by the change in other assets and
liabilities and First Western's lending activities. Included in cash flows from
operating activities is the lending activity of First Western relating to the
government guaranteed portion of the SBA 7(a) Program loans originated which
are sold into the secondary market ("Government Guaranteed Lending"). During
the years ended December 31, 1998 and 1997, the Company had a net source of
cash of $2,571,000 and $1,016,000, respectively, from Government Guaranteed
Lending activities representing an increase in source of funds of $1,555,000.
During the years ended December 31, 1998 and 1997, the Company used net cash of
$1,376,000 and $2,070,000, respectively, from the change in operating assets
and liabilities.

        The Company used $37,126,000 and $31,401,000, respectively from
investing activities during the years ended December 31, 1998 and 1997,
respectively. During the year ended December 31, 1997, the Company received
approximately $23.0 million from the First Western securitization completed in
December 1997. The Company decreased its use of funds relating to loan activity
from a net use of funds of $55,670,000 during the year ended December 31, 1997
to a net use of funds of $34,382,000 during the year ended December 31, 1998.
This decrease of $21,288,000 was due to a decrease in loans funded of
approximately $6.7 million and an increase in prepayment activity. Principal
collected increased by $14.7 million from $10.0 million during the year ended
December 31, 1997 to $24.7 million during the year ended December 31, 1998.

        The Company had a net source of $29,267,000 and a net use of
$11,695,000 from financing activities during the years ended December 31, 1998
and 1997, respectively. The primary reason for the change was the source of
$40.9 million in proceeds from the 1998 Structured Sale. There was no
comparable transaction during the year ended December 31, 1997. Dividends paid
on common stock during the year ended December 31, 1998 were $14,771,000 as
compared to $13,197,000 during the year ended December 31, 1997, an increase of
$1,574,000 (12%). The Company also had a decrease in funds received from the
issuance of common stock of $3,414,000 (62%) from $5,475,000 during the year
ended December 31, 1997 to $2,061,000 during the year ended December 31, 1998.
This decrease was a result of the curtailment of the cash portion of the
Company's dividend reinvestment plan during March 1998 and the utilization of
the market purchase option for plan participants. Under the market purchase
option, the Company does not receive any of the proceeds from plan
participants. SBA debenture repayments required at maturity decreased by
$1,780,000 from $3,280,000 during the year ended December 31, 1997 to
$1,500,000 during the year ended December 31, 1998.

LIQUIDITY AND CAPITAL RESOURCES

        SOURCES AND USES OF FUNDS: As a regulated investment company, pursuant
to the Internal Revenue Code of 1986, the Company is required to pay out
substantially all of its net investment company taxable income to the common
shareholders (see "Dividends"). Consequently, the Company must procure funds
from sources other than earnings in order to meet its capital requirements.

        The primary use of the Company's funds is to originate loans. The
Company also expends funds for payment of (i) dividends to shareholders, (ii)
principal due on borrowings, (iii) interest and related financing costs, (iv)
general and administrative expenses, (v) capital expenditures and (vi) advances
on loan liquidations. Approximately $4.8 million of the Company's SBA
debentures were paid in full during 1997 and 1998 as these debentures matured.

        Historically, the Company's primary sources of capital and liquidity
have been debentures issued through programs of the SBA, private and public
issuances of common stock, the issuance of senior unsecured medium-term notes,
the securitization and sale of its loan portfolio (see "Business - Leverage")
and the utilization of its short-term, unsecured revolving credit facility (as
described below). During 1998, the Company structured a collateralized
financing of its variable-rate loans primarily originated as part of the Prime
Lending Program ( see "Business - Leverage" ). Prospectively, in order to
generate growth in the size of its investment portfolio, the Company will
continually review the need for obtaining additional funds from: (i)
securitization and sale of a portion of the loan portfolio, (ii) borrowings
under its credit facility, (iii) medium-term debt offerings and/or (iv) equity
offerings. As a result of the current volatile market conditions for asset
backed securities such as securities sold by the Company, alternative sources
of funds have been identified by management. It is anticipated that during the
year ended December 31, 1999 the Company will primarily rely on its revolving
credit facility, the proceeds from principal payments on loans and the issuance
of SBA debentures to the extent funds are necessary to originate loans. The
Company will continue to monitor the asset backed securities market and to the
extent the pricing appears cost efficient, may structure and sell a pool of
fixed-rate loans. Presently, the Company has identified approximately $60
million of fixed-rate loans for securitization. During the year ended December
31, 1999, the 


                                      19
<PAGE>   22

Company will have $6.7 million in senior unsecured notes and $4.2 million in
SBA debentures which will mature. It is expected that the senior unsecured
notes will be renewed under substantially the same terms and conditions
presently outstanding. The SBA debentures are expected to be "rolled-over" into
new SBA debentures with 10 year maturities. As part of the SBA's commitment to
Western Financial and PMCIC to provide guaranties on $11.5 million in future
debentures, $4.2 million will be utilized for the "roll-over" debentures.
Management believes that these financing sources will enable the Company to
generate funds sufficient to meet both its short-term and long-term capital
needs.

        COMMITMENTS: Loan commitments outstanding at December 31, 1998 to
various prospective small business companies, including the unfunded portion of
projects in the construction phase, amounted to approximately $57.3 million. Of
these commitments, $19.8 million were for loans partially guaranteed by the SBA
of which approximately $16.7 million would be sold (when fully funded) into the
secondary market. Such commitments are made in the ordinary course of the
Company's business. Commitments to extend credit are agreements to lend to a
customer provided that the terms established in the contract are met.
Commitments generally have fixed expiration dates and require payment of a fee.
Since some commitments expire without the proposed loan closing, the total
commitment amounts do not necessarily represent future cash requirements.

        REVOLVING CREDIT FACILITY: PMC Capital has a $15 million
uncollateralized revolving credit facility which expires in March 2000. At
December 31, 1998, the Company had no borrowings outstanding under this
revolving credit facility, and had availability of $15 million. Advances
pursuant to the credit facility bear interest at the Company's option at either
the lender's prime rate less 50 basis points or LIBOR plus 175 basis points.
The credit facility requires the Company to meet certain covenants, the most
restrictive of which provides that the ratio of net charge-offs to net loans
receivable may not exceed 2%, and the ratio of assets to senior debt (as
defined in the credit facility) will not fall below 135%. At December 31, 1998
the Company was in compliance with all covenants of this facility.

        SBA DEBENTURES: Due to changes in the SBIC program increasing the cost
and availability of SBA debentures, the Company had been utilizing other
sources of funds to expand its loan portfolio through December 31, 1998. The
cost and terms of these other sources of funds are not as favorable as those
historically achieved on SBA debentures and SSBIC preferred stock; however, the
Company had been able to issue debt through private placement of notes and
generate working capital through the securitization and sale of a portion of
its portfolio at rates generally better than available through the the issuance
of SBA debentures under the relative terms in existence during the first half
of 1998. As the cost of funds through the issuance of asset-backed securities
increased during the latter half of 1998, the Company determined that the cost
of debentures through the SBIC program was again cost efficient. As a result,
the Company applied for and was approved by the SBA for the issuance of up to
$11.5 million in SBA debentures. It is anticipated that a significant portion
of these debentures will be issued during the year ended December 31, 1999
including $4.2 million for the "roll-over" of SBA debentures which mature in
1999.

        INVESTMENT COMPANY ACT REQUIREMENTS: PMC Capital is in compliance with
the requirement to maintain a minimum of 200% asset coverage of debt as defined
in sections 18 and 61 of the 1940 Act as modified by exemptive orders obtained
by the Company from the Securities and Exchange Commission.

        DIVIDENDS: PMC Capital has historically paid out 100% of its investment
company taxable income and not paid any return of capital. There are certain
timing differences between book and tax income, most notably the recognition of
commitment fees received and the recognition of income relating to the 1998
Private Placement. A portion of dividends paid during 1998 pertained to
earnings in 1997 including the effect of the gain from a securitization and
sale of certain loans originated by First Western completed in December 1997
(these amounts being the "Carry-Forward Amounts"). As a result of these timing
differences and the Carry-Forward Amounts, the payment and amount of dividends
does not necessarily coincide with the Company's earnings. The Company utilized
a substantial portion of its Carry-Forward Amounts during 1998 to pay
dividends. The Company presently anticipates that the dividend will be
stabilized at $0.25 per share, per quarter during 1999. The dividend paid on
January 11, 1999 was $0.25 per share. The Company may amend this stabilized
dividend policy as warranted by earnings.

YEAR 2000 COMPLIANCE UPDATE

        The Year 2000 issue concerns the potential impact of historic computer
software code that only utilized two digits to represent the calendar year
(e.g. "98" for "1998"). Software so developed, and not corrected, could produce
inaccurate or unpredictable results commencing January 1, 2000, when current
and future dates present a lower two digit year number than dates in the prior
century. The Company, similar to most financial services providers, is subject
to the potential impact of the Year 2000 issue due to the nature of financial
information. Potential impacts to the Company may arise from software, computer
hardware, and other equipment both within the Company's direct control and
outside of the Company's 


                                      20
<PAGE>   23

ownership, yet with which the Company electronically or operationally
interfaces. Regulators have intensively focused upon Year 2000 exposures,
issuing guidance concerning the responsibilities of senior management and
directors. Year 2000 testing and certification is being addressed as a key
safety and soundness issue in conjunction with these regulatory concerns.

        During 1998, the Company formed an internal review team to address,
identify and resolve any Year 2000 issues that encompasses operating and
administrative areas of the Company. In addition, executive management monitors
the status of the Company's Year 2000 remediation plans, where necessary, as
they relate to internally used software, computer hardware and use of computer
applications in the Company's servicing processes. In addition, the Company is
engaged in assessing the Year 2000 issue with significant suppliers.

        The assessment process relating to the Company's loan receivable
servicing operations has commenced. In addition, the Company has initiated
formal communications with its significant suppliers to determine the extent to
which the Company is vulnerable to those third parties' failure to remediate
their own Year 2000 issues.

        The Company intends to use internal resources to test the software for
Year 2000 modifications. The Company plans to substantially complete its Year
2000 assessment and remediation by the end of the second quarter of 1999. The
total project cost (while not considered to be material) has not yet been
determined. However, based on preliminary information, the majority of the
project cost will be attributable to employee time necessary to test the
present system and to meet future industry requirements and will accordingly be
expensed. To date, the Company has installed new personal computer terminals at
a cost of approximately $25,000 which was not related to any specific year 2000
concern. In addition, the Company has not incurred any material costs related
to the assessment of, and preliminary efforts in connection with its Year 2000
issues. The costs of the project and the date on which the Company plans to
complete its Year 2000 assessment and remediation are based on management's
estimates, which were derived utilizing assumptions of future events including
the continued availability of certain resources, third party modification plans
and other factors. However, there can be no guarantee that these estimates will
be achieved and actual results could differ significantly from those plans.
Specific factors that might cause differences from management's estimates
include, but are not limited to, completion by third parties (primarily the
Company's bank) of their Year 2000 evaluations and their required
modifications. Management believes that the Company is devoting the necessary
resources to identify and resolve significant Year 2000 issues in a timely
manner.

IMPACT OF INFLATION

        The Company does not believe that inflation materially affects its
business other than the impact that it may have on the securities markets, the
valuation of collateral underlying the loans and the relationship of the
valuations to underlying earnings. Those could all influence the value of the
Company's investments.

RISKS ASSOCIATED WITH FORWARD-LOOKING STATEMENTS INCLUDED IN THIS FORM 10-K

        This Form 10-K contains certain forward-looking statements within the
meaning of Section 27A of the Securities Act of 1933 and Section 21E of the
Securities Exchange Act of 1934, which are intended to be covered by the safe
harbors created thereby. These statements include the plans and objectives of
management for future operations, including plans and objectives relating to
future growth of the loan portfolio and availability of funds. The
forward-looking statements included herein are based on current expectations
that involve numerous risks and uncertainties. Assumptions relating to the
foregoing involve judgments with respect to, among other things, future
economic, competitive and market conditions and future business decisions, all
of which are difficult or impossible to predict accurately and many of which
are beyond the control of the Company. Although the Company believes that the
assumptions underlying the forward-looking statements are reasonable, any of
the assumptions could be inaccurate and, therefore, there can be no assurance
that the forward-looking statements included in this Form 10-K will prove to be
accurate. In light of the significant uncertainties inherent in the
forward-looking statements included herein, the inclusion of such information
should not be regarded as a representation by the Company or any other person
that the objectives and plans of the Company will be achieved.


                                      21
<PAGE>   24

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

         The Company is subject to market risk associated with changes in
         interest rates.

         The Company's balance sheet consists of two items subject to interest
         rate risk. First, a majority of the Company's investment portfolio
         consists of fixed interest rate loans. Given that the loans are priced
         at a fixed rate of interest, changes in interest rates should not have
         a direct impact on interest income. In addition, changes in market
         interest rates are not typically a significant factor in the board of
         directors' determination of fair value of these loans. Significant
         reductions in interest rates, however, can prompt increased
         prepayments of the Company's loans, resulting in possible decreases in
         long-term revenues due to the relending of the prepayment proceeds at
         lower interest rates (See "Item 1. Business - Interest Rate and
         Prepayment Risk"). Second, the Company's liabilities consist of debt
         payable to the SBA and the Company's senior unsecured debt. The SBA
         debentures and the senior unsecured debt are payable at fixed rates of
         interest, so changes in interest rates do not affect the Company's
         interest expense (See "Business - Leverage and Interest Rate and
         Prepayment Risk").

ITEM 8.  CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

         The financial statements and supplementary data are included in this
         report beginning on page F-1.

ITEM 9.  CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
         FINANCIAL DISCLOSURE

         None


                                      22
<PAGE>   25
                                    PART III


ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

         Incorporated herein by reference to the Company's definitive proxy
statement to be filed with the Securities and Exchange Commission within 120
days after the year end covered by this Form 10-K with respect to the Annual
Meeting of Shareholders to be held on May 12, 1999.


ITEM 11. EXECUTIVE COMPENSATION

         Incorporated herein by reference to the Company's definitive proxy
statement to be filed with the Securities and Exchange Commission within 120
days after the year end covered by this Form 10-K with respect to the Annual
Meeting of Shareholders to be held on May 12, 1999.


ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

         Incorporated herein by reference to the Company's definitive proxy
statement to be filed with the Securities and Exchange Commission within 120
days after the year end covered by this Form 10-K with respect to the Annual
Meeting of Shareholders to be held on May 12, 1999.


ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

         Incorporated herein by reference to the Company's definitive proxy
statement to be filed with the Securities and Exchange Commission within 120
days after the year end covered by this Form 10-K with respect to the Annual
Meeting of Shareholders to be held on May 12, 1999.


                                      23
<PAGE>   26

                                    PART IV


ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K

         (a) Documents filed as part of this report:

             (1) Financial Statements
                    See index to Financial Statements set forth on page F-1 of
                    this Form 10-K.

             (2) Financial Statement Schedules

                    All schedules are omitted because they are not required
                    under the related instructions or not applicable, or because
                    the required information is included in the consolidated
                    financial statements or notes thereto.

             (3) Exhibits
                    See Exhibit Index beginning on page E-1 of this Form 10-K.

         (b) Reports on Form 8-K:

                 None


                                      24
<PAGE>   27

                                   SIGNATURES

         Pursuant to the requirements of Section 13 or 15(d) or 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.

                                          PMC Capital, Inc.

                                          By: /s/ Lance B. Rosemore
                                              -------------------------------
                                                  Lance B. Rosemore, President

Dated March 30, 1999

         Pursuant to the requirements of the Securities Act of 1934, this
report has been signed by the following persons in the capacities and on the
dates indicated.

<TABLE>
<CAPTION>
             Name                             Title                             Date
             ----                             -----                             ----
<S>                                    <C>                                  <C>

/s/ DR. FREDRIC M. ROSEMORE            Chairman of the Board                March 30, 1999
---------------------------------      and Treasurer
DR. FREDRIC M. ROSEMORE


/s/ LANCE B. ROSEMORE                  President, Chief Executive           March 30, 1999
---------------------------------      Officer, Secretary and Director
LANCE B. ROSEMORE                      (Principal Executive Officer)


/s/ DR. ANDREW S. ROSEMORE             Executive Vice President,            March 30, 1999
---------------------------------      Chief Operating Officer
DR. ANDREW S. ROSEMORE                 and Director


/s/ BARRY N. BERLIN                    Chief Financial Officer              March 30, 1999
---------------------------------      (Principal Financial and
BARRY N. BERLIN                        Accounting Officer)


                                       Director                             
---------------------------------
LEE RUWITCH


/s/ DR. MARTHA GREENBERG               Director                             March 30, 1999
---------------------------------
DR. MARTHA GREENBERG


/s/ DR. IRVIN BORISH                   Director                             March 30, 1999
---------------------------------
DR. IRVIN BORISH


/s/ THOMAS HAMILL                      Director                             March 30, 1999
---------------------------------
THOMAS HAMILL


/s/ ROBERT DIAMOND                     Director                             March 30, 1999
---------------------------------
ROBERT DIAMOND


/s/ BARRY IMBER                        Director                             March 30, 1999
---------------------------------
BARRY IMBER
</TABLE>


                                      25
<PAGE>   28
                      PMC CAPITAL, INC. AND SUBSIDIARIES
                                   FORM 10-K
                         INDEX TO FINANCIAL STATEMENTS


<TABLE>
<S>                                                                                                                <C>
PMC CAPITAL, INC. AND SUBSIDIARIES

    Summary of Selected Financial Information......................................................................F-2

    Quarterly Statistics...........................................................................................F-3

    Report of Independent Accountants..............................................................................F-4

    Consolidated Financial Statements:

        Financial Highlights.......................................................................................F-5

        Consolidated Balance Sheets as of December 31, 1998 and 1997...............................................F-6

        Consolidated Schedule of Investments as of December 31, 1998...............................................F-7

        Consolidated Statements of Income for the Years Ended December 31, 1998, 1997 and 1996.....................F-9

        Consolidated Statements of Shareholders' Equity for the Years Ended December 31, 1998, 1997 and 1996.......F-10

        Consolidated Statements of Cash Flows for the Years Ended December 31, 1998, 1997 and 1996.................F-11

        Notes to Consolidated Financial Statements.................................................................F-12

    Consolidating Financial Statements:

        Report of Independent Accountants on Consolidating Financial Statements ...................................F-28

        Consolidating Balance Sheet as of December 31, 1998........................................................F-29

        Consolidating Statement of Income for the Year Ended December 31, 1998.....................................F-30

        Consolidating Statement of Shareholders' Equity for the Year Ended December 31, 1998.......................F-31

        Consolidating Statement of Cash Flows for the Year Ended December 31, 1998.................................F-32


PMC CAPITAL LIMITED PARTNERSHIP

    Report of Independent Accountants..............................................................................F-33

    Statements of Assets, Liabilities and Partners' Capital as of December 31, 1998 and 1997.......................F-34

    Statements of Income for the years ended December 31, 1998 and 1997 and for the Period From
          November 8, 1996 (Inception) to December 31, 1996........................................................F-35

    Statements of Partners' Capital for the years ended December 31, 1998 and 1997 and for the Period From
          November 8, 1996 (Inception) to December 31, 1996........................................................F-36

    Statements of Cash Flows for the years ended December 31, 1998 and 1997 and for the Period From
          November 8, 1996 (Inception) to December 31, 1996........................................................F-37

    Notes to Financial Statements..................................................................................F-38

PMC CAPITAL, L.P. 1998-1

    Report of Independent Accountants..............................................................................F-42

    Statement of Assets, Liabilities and Partners' Capital as of December 31, 1998.................................F-43

    Statement of Income for the Period From November 24, 1998 (Inception) to December 31, 1998.....................F-44

    Statement of Partners' Capital for the Period From November 24, 1998 (Inception) to December 31, 1998..........F-45

    Statement of Cash Flows for the Period From November 24, 1998 (Inception) to December 31, 1998.................F-46

    Notes to Financial Statements..................................................................................F-47
</TABLE>


                                      F-1
<PAGE>   29
                       PMC CAPITAL, INC. AND SUBSIDIARIES
                   SUMMARY OF SELECTED FINANCIAL INFORMATION


<TABLE>
<CAPTION>
                                                                                 Years Ended December 31,
                                                          ----------------------------------------------------------------------
                                                             1998           1997           1996           1995           1994
                                                          ----------     ----------     ----------     ----------     ----------
                                                                    (in thousands, except per share data and ratios)
<S>                                                       <C>            <C>            <C>            <C>            <C>       
Operating:

Operating income ......................................   $   24,314     $   24,406     $   23,821     $   21,262     $   16,450

Operating expenses ....................................      (11,091)       (10,602)       (10,454)        (9,541)        (7,578)

Realized and unrealized gain (loss) on investments ....          726          1,818           (147)          (359)         3,151
                                                          ----------     ----------     ----------     ----------     ----------
Net operating income and realized and unrealized
  gain (loss) on investments ..........................   $   13,949     $   15,622     $   13,220     $   11,362     $   12,023
                                                          ==========     ==========     ==========     ==========     ==========
Dividends declared, common ............................   $   14,473     $   14,543     $   12,853     $   11,600     $   11,244
                                                          ==========     ==========     ==========     ==========     ==========
Earnings per common share .............................   $     1.16     $     1.35     $     1.18     $     1.03     $     1.12
                                                          ==========     ==========     ==========     ==========     ==========
Dividends per common share ............................   $     1.23     $     1.27     $     1.16     $     1.08     $     1.06
                                                          ==========     ==========     ==========     ==========     ==========
Weighted average common shares outstanding ............       11,800         11,411         11,002         10,768         10,650
                                                          ==========     ==========     ==========     ==========     ==========
Loans funded ..........................................   $   66,450     $   86,361     $   70,154     $   77,567     $   75,349
                                                          ==========     ==========     ==========     ==========     ==========
At end of period:

Loans receivable, net .................................   $  116,711     $  127,240     $   93,354     $  110,499     $   75,264
                                                          ==========     ==========     ==========     ==========     ==========
Total assets ..........................................   $  163,349     $  165,839     $  164,964     $  159,002     $  125,416
                                                          ==========     ==========     ==========     ==========     ==========
SBA debentures payable ................................   $   39,790     $   41,290     $   44,570     $   43,540     $   26,280
                                                          ==========     ==========     ==========     ==========     ==========
Notes payable .........................................   $   35,000     $   35,000     $   35,000     $   35,001     $   25,001
                                                          ==========     ==========     ==========     ==========     ==========
Preferred stock of consolidated subsidiary ............   $    7,000     $    7,000     $    7,000     $    7,000     $    5,000
                                                          ==========     ==========     ==========     ==========     ==========
Common shareholders' equity ...........................   $   72,151     $   70,166     $   62,903     $   59,088     $   57,371
                                                          ==========     ==========     ==========     ==========     ==========
Number of common shares outstanding ...................       11,829         11,631         11,162         10,871         10,684
                                                          ==========     ==========     ==========     ==========     ==========
Ratios:

Return on average assets ..............................          8.5%           9.7%           8.3%           8.0%          10.3%
                                                          ==========     ==========     ==========     ==========     ==========
Return on average common shareholders' equity .........         19.2%          23.3%          21.3%          19.2%          21.2%
                                                          ==========     ==========     ==========     ==========     ==========
</TABLE>


                                      F-2
<PAGE>   30
                   PMC CAPITAL, INC. AND SUBSIDIARIES
                          QUARTERLY STATISTICS
                               (Unaudited)
                  (in thousands except per share data)

<TABLE>
<CAPTION>
                                                            YEAR ENDED DECEMBER 31, 1998
                                           ------------------------------------------------------------------
                                             First        Second         Third        Fourth
                                            Quarter       Quarter       Quarter       Quarter         Total
                                           ----------    ----------    ----------    ----------    ----------

<S>                                        <C>           <C>           <C>           <C>           <C>       
Operating income .......................   $    5,790    $    6,441    $    6,049    $    6,034    $   24,314

Net operating income ...................   $    3,068    $    3,788    $    3,369    $    2,998    $   13,223

Net gain (loss) on investments .........   $      224    $     (457)   $       90    $      869    $      726

Net increase in net assets
     resulting from operations .........   $    3,292    $    3,331    $    3,459    $    3,867    $   13,949

-------------------------------------------------------------------------------------------------------------
                                                  PER SHARE
-------------------------------------------------------------------------------------------------------------

Operating income .......................   $    0.494    $    0.545    $    0.511    $    0.510    $    2.060

Net operating income ...................   $    0.262    $    0.321    $    0.285    $    0.253    $    1.121

Net gain (loss) on investments .........   $    0.019    $   (0.039)   $    0.008    $    0.073    $    0.061

Net increase in net assets
     resulting from operations .........   $    0.281    $    0.282    $    0.293    $    0.326    $    1.182
</TABLE>


<TABLE>
<CAPTION>
                                                            YEAR ENDED DECEMBER 31, 1997
                                           ------------------------------------------------------------------
                                             First        Second         Third        Fourth
                                            Quarter       Quarter       Quarter       Quarter         Total
                                           ----------    ----------    ----------    ----------    ----------
<S>                                        <C>           <C>           <C>           <C>           <C>       
Operating income .......................   $    5,954    $    6,103    $    6,082    $    6,267    $   24,406

Net operating income ...................   $    3,324    $    3,488    $    3,471    $    3,521    $   13,804

Net gain (loss) on investments .........   $      (57)   $       38    $      (20)   $    1,857    $    1,818

Net increase in net assets
     resulting from operations .........   $    3,267    $    3,526    $    3,451    $    5,378    $   15,622

-------------------------------------------------------------------------------------------------------------
                                                  PER SHARE
-------------------------------------------------------------------------------------------------------------

Operating income .......................   $    0.530    $    0.538    $    0.531    $    0.540    $    2.139

Net operating income ...................   $    0.296    $    0.307    $    0.303    $    0.303    $    1.209

Net gain (loss) on investments .........   $   (0.005)   $    0.003    $   (0.002)   $    0.160    $    0.156

Net increase in net assets
     resulting from operations .........   $    0.291    $    0.310    $    0.301    $    0.463    $    1.365
</TABLE>


                                      F-3
<PAGE>   31

                       REPORT OF INDEPENDENT ACCOUNTANTS



To the Shareholders and Board of Directors
PMC Capital, Inc.:


In our opinion, the accompanying consolidated balance sheets as of December 31,
1998 and 1997, including the schedule of investments as of December 31, 1998
and the related consolidated statements of income, shareholders' equity and
cash flows for each of the three years in the period ended December 31, 1998
and the financial highlights for each of the five years in the period ended
December 31, 1998 present fairly, in all material respects, the financial
position of PMC Capital, Inc. and its subsidiaries at December 31, 1998 and
1997 and the results of their operations and their cash flows and the financial
highlights for the periods indicated, in conformity with generally accepted
accounting principles. These financial statements and financial highlights
(hereafter referred to as "financial statements") are the responsibility of the
Company's management; our responsibility is to express an opinion on these
financial statements based on our audits. We conducted our audits of these
financial statements in accordance with generally accepted auditing standards
which require that we plan and perform the audit to obtain reasonable assurance
about whether the financial statements are free of material misstatement. An
audit includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits, which included
examination or confirmation of securities owned as of December 31, 1998 and 
1997, provide a reasonable basis for the opinion expressed above.

                                            PRICEWATERHOUSECOOPERS LLP

March 4, 1999
Dallas, Texas


                                      F-4


<PAGE>   32
--------------------------------------------------------------------------------
                       PMC CAPITAL, INC. AND SUBSIDIARIES
                              FINANCIAL HIGHLIGHTS
--------------------------------------------------------------------------------

        The following financial highlights of the Company should be read in
conjunction with the consolidated financial statements and the notes thereto
appearing elsewhere on this Form 10-K. The financial highlights below provide
information about the Company's financial history. It uses the Company's fiscal
year (which ends December 31) and expresses the per share operating performance
in terms of a single share outstanding throughout each fiscal period. The
information is derived from the audited consolidated financial statements. The
financial highlights have been audited by PricewaterhouseCoopers LLP,
independent accountants.

<TABLE>
<CAPTION>
                                                                                     Years Ended December 31,
                                                                ------------------------------------------------------------------
                                                                   1998          1997          1996          1995          1994
                                                                ----------    ----------    ----------    ----------    ----------
<S>                                                             <C>           <C>           <C>           <C>           <C>       
Per share operating performance (1):
        Net asset value, beginning of period ................   $     6.03    $     5.64    $     5.44    $     5.37    $     5.24
                                                                ----------    ----------    ----------    ----------    ----------

        Net operating income ................................         1.12          1.21          1.21          1.09          0.83
        Net gains or losses on securities
          realized and unrealized (2) .......................         0.20          0.47          0.17          0.08          0.37
                                                                ----------    ----------    ----------    ----------    ----------
            Total from investment operations ................         1.32          1.68          1.38          1.17          1.20
                                                                ----------    ----------    ----------    ----------    ----------

        Less distributions:
          Preferred shareholder of consolidated subsidiary ..         0.02          0.02          0.02          0.02          0.01
          Common shareholders ...............................         1.23          1.27          1.16          1.08          1.06
                                                                ----------    ----------    ----------    ----------    ----------

             Total distributions ............................         1.25          1.29          1.18          1.10          1.07
                                                                ----------    ----------    ----------    ----------    ----------

        Net asset value, end of period ......................   $     6.10    $     6.03    $     5.64    $     5.44    $     5.37
                                                                ==========    ==========    ==========    ==========    ==========

        Per share market value, end of period ...............   $     8.56    $    14.56    $    14.00    $    12.63    $    13.50
                                                                ==========    ==========    ==========    ==========    ==========

        Total investment return .............................          (33)%          13%           20%            2%            0%
                                                                ==========    ==========    ==========    ==========    ==========

RATIOS AND SUPPLEMENTAL DATA:
        Net assets, end of period (in thousands) ............   $   72,151    $   70,166    $   62,903    $   59,088    $   57,371
                                                                ==========    ==========    ==========    ==========    ==========
        Ratio of expenses to average net assets .............           16%           16%           17%           16%           13%
                                                                ==========    ==========    ==========    ==========    ==========
        Ratio of operating income to average net assets .....           19%           21%           22%           20%           16%
                                                                ==========    ==========    ==========    ==========    ==========
        Ratio of net operating income and realized and
          unrealized gain (loss) on investments to
          average net assets ................................           20%           24%           22%           20%           21%
                                                                ==========    ==========    ==========    ==========    ==========
        Portfolio turnover (3) ..............................           58%           20%           16%           30%           65%
                                                                ==========    ==========    ==========    ==========    ==========
</TABLE>


FOOTNOTES:

(1)   The per share changes during the year are based on the weighted average
        number of shares outstanding of the Company during the year presented.

(2)   The per share net gains or losses on securities (realized and
        unrealized) includes the effect of stock issuances and other changes in
        per share amounts during the year presented.

(3)   Included in the computation of the portfolio turnover rate are the sales
        of loans through the secondary market or private placement.



                                      F-5
<PAGE>   33
                       PMC CAPITAL, INC. AND SUBSIDIARIES
                           CONSOLIDATED BALANCE SHEETS
                ( IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)

<TABLE>
<CAPTION>
                                                                             DECEMBER 31,
                                                                       ----------------------
                                                                          1998         1997
                                                                       ---------    ---------
<S>                                                                    <C>          <C>      
                                 ASSETS
Investments at value:
  Loans receivable, net ............................................   $ 116,711    $ 127,240
  Cash equivalents .................................................      18,489       17,237
  Investment in unconsolidated subsidiaries ........................      12,930        7,797
  Interest-only strip receivables ..................................       4,168        3,708
  Restricted investments ...........................................       2,525        2,798
  Mortgage-backed security of affiliate ............................       2,168           -- 
  Real property owned ..............................................         109          296
                                                                       ---------    ---------

TOTAL INVESTMENTS AT VALUE .........................................     157,100      159,076
                                                                       ---------    ---------

OTHER ASSETS:
  Receivable for loans sold ........................................         156        1,346
  Due from unconsolidated subsidiaries .............................       2,579        1,302
  Servicing asset ..................................................       1,330        1,607
  Deferred charges, deposits and other assets ......................       1,140        1,398
  Accrued interest receivable ......................................         581          608
  Cash .............................................................         235          265
  Property and equipment, net ......................................         228          237
                                                                       ---------    ---------

TOTAL OTHER ASSETS .................................................       6,249        6,763
                                                                       ---------    ---------

TOTAL ASSETS .......................................................   $ 163,349    $ 165,839
                                                                       =========    =========

                  LIABILITIES AND SHAREHOLDERS' EQUITY
LIABILITIES:
  SBA debentures payable ...........................................   $  39,790    $  41,290
  Notes payable ....................................................      35,000       35,000
  Accounts payable .................................................       1,728        3,269
  Dividends payable ................................................       3,020        4,018
  Borrower advances ................................................       1,598        1,678
  Accrued interest payable .........................................       1,264        1,316
  Due to unconsolidated subsidiaries ...............................           1          279
  Deferred fee revenue .............................................         666          571
  Other liabilities ................................................       1,131        1,252
                                                                       ---------    ---------

TOTAL LIABILITIES ..................................................      84,198       88,673
                                                                       ---------    ---------

Commitments and contingencies

CUMULATIVE PREFERRED STOCK OF SUBSIDIARY ...........................       7,000        7,000
                                                                       ---------    ---------

SHAREHOLDERS' EQUITY:
  Common stock, authorized 30,000,000 shares of $.01 par value,
       11,829,000 and 11,631,000 shares issued and outstanding
       at December 31, 1998 and 1997, respectively .................         118          116
  Additional paid-in capital .......................................      71,312       68,555
  Undistributed net operating income ...............................       1,495        2,289
  Net unrealized depreciation on investments .......................        (774)        (794)
                                                                       ---------    ---------

                                                                          72,151       70,166
                                                                       ---------    ---------

TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY .........................   $ 163,349    $ 165,839
                                                                       =========    =========

NET ASSET VALUE PER COMMON SHARE ...................................   $    6.10    $    6.03
                                                                       =========    =========
</TABLE>


              THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE
                       CONSOLIDATED FINANCIAL STATEMENTS.



                                      F-6
<PAGE>   34
                        PMC CAPITAL INC. AND SUBSIDIARIES
                      CONSOLIDATED SCHEDULE OF INVESTMENTS
                                DECEMBER 31, 1998
                             (DOLLARS IN THOUSANDS)

<TABLE>
<CAPTION>
                                                                   RETAINED LOANS                           SERVICED LOANS (2)
                                                    -----------------------------------------------    -----------------------------
                                                      NUMBER                                           NUMBER
                                                      OF                                               OF
               CATEGORY / ISSUER (1)                  LOANS     VALUE       %        COST       %      LOANS      COST         %
               ---------------------                  ------   --------   -----    --------   -----    -----    --------     -----
<S>                                                       <C>  <C>          <C>    <C>          <C>      <C>    <C>           <C>  
LOANS TO SMALL BUSINESS CONCERNS (3):
      SMALL BUSINESS LENDING COMPANY LOANS:
      FIRST WESTERN SBLC, INC. AND SUBSIDIARY
        Hotels and motels .......................         54   $  4,383     3.8%   $  4,554     3.9%     100    $ 71,293      24.9%
        Gasoline / service stations .............         10        107      --         117      --       14       4,041       1.4%
        Restaurants .............................         27      1,039     0.9%      1,127     1.0%      57      11,066       3.9%
        Laundromats .............................          8        163     0.2%        170     0.2%      11       1,504       0.5%
        Retail, other ...........................         29      1,671     1.4%      1,721     1.5%      53       7,480       2.6%
        Health care .............................          8         33      --          36      --       11         678       0.2%
        Food and grocery stores .................          6        104     0.1%        104      --        8       1,805       0.6%
        Services ................................         41        837     0.7%        897     0.8%      77      11,871       4.2%
        Manufacturing ...........................         10         67     0.1%         70     0.1%      11       2,226       0.8%
        Wholesale ...............................         12        137     0.1%        142     0.1%      16       2,654       0.9%
        Car washes ..............................          1        382     0.3%        382     0.3%       2         468       0.2%
                                                      ------   --------   -----    --------   -----    -----    --------     -----
      Total .....................................        206      8,923     7.6%      9,320     7.9%     360     115,086      40.2%
                                                      ------   --------   -----    --------   -----    -----    --------     -----

      SMALL BUSINESS INVESTMENT COMPANY LOANS:
      WESTERN FINANCIAL CAPITAL CORPORATION
        Hotels and motels .......................         27     17,272    14.8%     17,370    14.7%      34      22,697       7.9%
        Gasoline / service stations .............          1        321     0.3%        321     0.3%       5       1,905       0.7%
        Restaurants .............................         --         --      --          --      --        2       1,299       0.4%
        Retail, other ...........................          2      1,473     1.3%      1,515     1.3%       3       1,614       0.6%
        Services ................................          6        828     0.7%        842     0.7%      13       3,573       1.2%
        Health care .............................         13        377     0.3%        394     0.3%      15         907       0.3%
        Food and grocery stores .................          1        116     0.1%        116     0.1%       1         116        --
        Manufacturing ...........................          1         39      --          39      --        1          39        --
        Agriculture .............................          1        495     0.4%        499     0.4%       2         861       0.3%
        Other notes receivable ..................          5        311     0.3%        341     0.3%       6         750       0.3%
                                                      ------   --------   -----    --------   -----    -----    --------     -----
      Total .....................................         57     21,232    18.2%     21,437    18.1%      82      33,761      11.7%
                                                      ------   --------   -----    --------   -----    -----    --------     -----

      SPECIALIZED SMALL BUSINESS INVESTMENT
         COMPANY LOANS:
      PMC INVESTMENT CORPORATION
        Hotels and motels .......................         50     39,300    33.7%     39,723    33.6%      81      63,856      22.3%
        Gasoline / service stations .............          6      2,486     2.1%      2,515     2.1%      11       4,434       1.6%
        Retail, other ...........................          1         35      --          35      --        1          35        --
        Services ................................          2        102      --         102      --        3         443       0.2%
        Health care .............................          7        289     0.2%        289     0.3%       7         289       0.1%
        Food and grocery stores .................          3        740     0.6%        745     0.6%       4         776       0.3%
        Other notes receivable ..................          2        217     0.2%        717     0.6%       2         717       0.2%
                                                      ------   --------   -----    --------   -----    -----    --------     -----
      Total .....................................         71     43,169    37.0%     44,126    37.2%     109      70,550      24.7%
                                                      ------   --------   -----    --------   -----    -----    --------     -----

      COMMERCIAL LOANS:
      PMC CAPITAL, INC ..........................
        Hotels and motels .......................         36     38,650    33.1%     38,672    32.7%      60      60,360      21.2%
        Gasoline / service stations .............          2        492     0.4%        493     0.4%       2         493       0.2%
        Retail, other ...........................          2      1,816     1.6%      1,818     1.5%       2       1,818       0.6%
        Services ................................          3        533     0.5%        533     0.5%       4       1,430       0.5%
        Commercial real estate ..................          3      1,117     1.0%      1,124     1.0%       4       1,682       0.6%
        Apartment complex .......................          1        779     0.7%        784     0.7%       1         784       0.3%
                                                      ------   --------   -----    --------   -----    -----    --------     -----
      Total .....................................         47     43,387    37.2%     43,424    36.8%      73      66,567      23.4%
                                                      ------   --------   -----    --------   -----    -----    --------     -----

      TOTAL LOANS RECEIVABLE (4) ................        381   $116,711   100.0%   $118,307   100.0%     624    $285,964     100.0%
                                                      ======   ========   =====    ========   =====    =====    ========     =====
</TABLE>


                           (Continued on next page )



                                      F-7

<PAGE>   35
                        PMC CAPITAL INC. AND SUBSIDIARIES
                      CONSOLIDATED SCHEDULE OF INVESTMENTS
                                DECEMBER 31, 1998
              ( CONTINUED --  DOLLARS IN THOUSANDS, EXCEPT FOOTNOTES)

<TABLE>
<CAPTION>
          CATEGORY / ISSUER                                                     VALUE          %         COST        %
          -----------------                                                 ---------      -----     ---------   ----- 
<S>                                                                           <C>            <C>       <C>         <C> 
TOTAL LOANS RECEIVABLE (FROM PRIOR PAGE) ..................................   $ 116,711       74.3%    $ 118,307    74.5%
                                                                              ---------      -----     ---------   ----- 
MONEY MARKET AND FUND DEPOSIT ACCOUNTS (5):
          Bank money market saving accounts ...............................       7,104        4.5%        7,104     4.5%
          SunTrust, overnight repo account ................................       1,327        0.8%        1,327     0.8%
          Dreyfus, Cash Management Plus money market fund .................       4,026        2.6%        4,026     2.5%
          Goldman Sachs,  money market fund ...............................       2,011        1.3%        2,011     1.3%
          Goldman Sachs,  Prime Obligation money market fund ..............       4,021        2.6%        4,021     2.5%
                                                                              ---------      -----     ---------   ----- 
        Total money market and fund deposit accounts ......................      18,489       11.8%       18,489    11.6%
                                                                              ---------      -----     ---------   ----- 

INVESTMENT IN UNCONSOLIDATED SUBSIDIARIES:
          Investment in PMC Limited Partnership and affiliates ............       7,092        4.5%        7,092     4.5%
          Investment in PMC Advisers, Ltd. and subsidiary .................         205         --           205      -- 
          Investment in PMC Capital L.P. 1998-1 and affiliate .............       5,649        3.6%        5,649     3.6%
          Investment in PMC Funding Corp. and subsidiary ..................         (16)        --           (16)     -- 
                                                                              ---------      -----     ---------   ----- 
        Total investment in unconsolidated subsidiaries ...................      12,930        8.2%       12,930     8.1%
                                                                              ---------      -----     ---------   ----- 

OTHER INVESTMENTS:
          Interest-only strip receivable ..................................       4,168        2.7%        4,348     2.7%
          Investment in Class B certificate of PMC Capital L.P. 1998-1 ....       2,168        1.4%        2,168     1.4%
          SunBank Miami, restricted investments ...........................         817        0.5%          817     0.7%
          Bank One Trust Company, restricted investments ..................       1,708        1.1%        1,708     0.7%
          Real property owned .............................................         109        0.1%          109     0.1%
                                                                              ---------      -----     ---------   ----- 
        Total other investments ...........................................       8,970        5.7%        9,150     4.8%
                                                                              ---------      -----     ---------   ----- 

TOTAL INVESTMENTS (6) .....................................................   $ 157,100      100.0%    $ 158,876   100.0%
                                                                              =========      =====     =========   =====
</TABLE>


(1)   Names have been omitted as disclosure to the public may be detrimental
        to the small business.

(2)   Balances include retained loans, loans sold into the secondary market (
        $82.9 million ), the loans contributed to the Partnerships ( $61.9
        million ) and the unguaranteed portion of First Western loans sold and
        serviced ( $22.9 million ). The balance does not include approximately
        $121.4 million of loan portfolio serviced on behalf of PMC Commercial
        Trust.

(3)   Interest rates on loans receivable range from 8.0% to 14.5%.

(4)   Balances are at face value of loans, less discounts aggregating $330,000
        in accordance with Emerging Issues Task Force 88-11, discounts on
        purchased loans of $61,000, unamortized fee revenue of $611,000 and
        reserves of $594,000.

(5)   Interest or dividend rates on money market and fund deposit accounts
        range from 4% to 5%.

(6)   The aggregate cost of investments for Federal income tax purposes is
        approximately $160 million.


              THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE
                       CONSOLIDATED FINANCIAL STATEMENTS.



                                      F-8


<PAGE>   36
                       PMC CAPITAL, INC. AND SUBSIDIARIES
                        CONSOLIDATED STATEMENTS OF INCOME
                      (IN THOUSANDS, EXCEPT PER SHARE DATA)

<TABLE>
<CAPTION>
                                                                       YEARS ENDED DECEMBER 31,
                                                                 ------------------------------------
                                                                   1998          1997          1996
                                                                 --------      --------      --------
<S>                                                              <C>           <C>           <C>     
Investment income:
  Interest .................................................     $ 17,214      $ 17,136      $ 18,571
  Premium income ...........................................          776         1,776         1,942
  Other investment income, net .............................          807           504           608
                                                                 --------      --------      --------

Total investment income ....................................       18,797        19,416        21,121

Other income, net ..........................................        2,893         2,430         2,331
Equity in income of unconsolidated subsidiaries, net .......        2,624         2,560           369
                                                                 --------      --------      --------

Total income ...............................................       24,314        24,406        23,821
                                                                 --------      --------      --------

EXPENSES:
  Interest .................................................        5,467         5,548         5,708
  Salaries and related benefits ............................        3,965         3,435         3,180
  General and administrative ...............................          821           797           843
  Profit sharing plan ......................................          243           243           217
  Rent .....................................................          244           229           213
  Legal and accounting .....................................          182           192           149
  Small Business Administration fees .......................          106           108            99
  Directors and shareholders expense .......................           63            50            45
                                                                 --------      --------      --------

Total expenses .............................................       11,091        10,602        10,454
                                                                 --------      --------      --------


Net  operating income ......................................       13,223        13,804        13,367
                                                                 --------      --------      --------

REALIZED AND UNREALIZED GAIN (LOSS)
  ON INVESTMENTS:
    Loans written-off ......................................         (219)         (183)         (214)
    Recoveries on loans written-off ........................           --            --            35
    Sale of assets .........................................          925         2,360            -- 
    Change in unrealized appreciation
      (depreciation) on investments ........................           20          (359)           32
                                                                 --------      --------      --------

Total realized and unrealized gain (loss) on investments ...          726         1,818          (147)
                                                                 --------      --------      --------

NET OPERATING INCOME AND REALIZED AND UNREALIZED
  GAIN (LOSS) ON INVESTMENTS ...............................     $ 13,949      $ 15,622      $ 13,220
                                                                 ========      ========      ========


PREFERRED DIVIDENDS ........................................     $    250      $    250      $    251
                                                                 ========      ========      ========

WEIGHTED AVERAGE COMMON SHARES OUTSTANDING .................       11,800        11,411        11,002
                                                                 ========      ========      ========

BASIC AND DILUTED EARNINGS PER COMMON SHARE ................     $   1.16      $   1.35      $   1.18
                                                                 ========      ========      ========
</TABLE>


              THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE
                       CONSOLIDATED FINANCIAL STATEMENTS.



                                      F-9


<PAGE>   37
                       PMC CAPITAL, INC. AND SUBSIDIARIES
                 CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
              FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
                 (IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)

<TABLE>
<CAPTION>
                                                                                                       NET
                                                                               UNDISTRIBUTED        UNREALIZED
                                                               ADDITIONAL            NET           DEPRECIATION
                                                 COMMON         PAID-IN           OPERATING             ON
                                                 STOCK          CAPITAL            INCOME           INVESTMENTS          TOTAL
                                                 ------        ----------      -------------       ------------        --------
<S>              <C>                             <C>            <C>               <C>                 <C>              <C>     
BALANCE, JANUARY 1, 1996 .............           $109           $58,429           $  1,017            $(467)           $ 59,088

Issuances of common stock pursuant
  to dividend reinvestment and cash
  purchase plan, 291,042 shares ......              3             3,696                 --               --               3,699

Net income ...........................             --                --             13,188               32              13,220

Dividends:

  Preferred ..........................             --                --               (251)              --                (251)

  Common ($1.16 per common share) ....             --                --            (12,853)              --             (12,853)
                                                 ----           -------           --------            -----            --------
BALANCE, DECEMBER 31, 1996 ...........            112            62,125              1,101             (435)             62,903

Issuances of common stock pursuant
  to dividend reinvestment and cash
  purchase plan, 468,706 shares ......              4             6,430                 --               --               6,434

Net income ...........................             --                --             15,981             (359)             15,622

Dividends:

  Preferred ..........................             --                --               (250)              --                (250)

  Common ($1.27 per common share) ....             --                --            (14,543)              --             (14,543)
                                                 ----           -------           --------            -----            --------
BALANCE, DECEMBER 31, 1997 ...........            116            68,555              2,289             (794)             70,166

Issuances of common stock pursuant
  to dividend reinvestment and cash
  purchase plan, 198,329 shares ......              2             2,757                 --               --               2,759

Net income ...........................             --                --             13,929               20              13,949

Dividends:

  Preferred ..........................             --                --               (250)              --                (250)

  Common ($1.23 per common share) ....             --                --            (14,473)              --             (14,473)
                                                 ----           -------           --------            -----            --------
BALANCE,  DECEMBER 31, 1998 ..........           $118           $71,312           $  1,495            $(774)           $ 72,151
                                                 ====           =======           ========            =====            ========
</TABLE>


              THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE
                       CONSOLIDATED FINANCIAL STATEMENTS.



                                      F-10

<PAGE>   38
                       PMC CAPITAL, INC. AND SUBSIDIARIES
                      CONSOLIDATED STATEMENTS OF CASH FLOWS
              FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
                                 (IN THOUSANDS)

<TABLE>
<CAPTION>
                                                                                                YEARS ENDED DECEMBER 31,
                                                                                          ------------------------------------
                                                                                            1998          1997          1996
                                                                                          --------      --------      --------
<S>                                                                                       <C>           <C>           <C>     
CASH FLOWS FROM OPERATING ACTIVITIES:
  Net operating income and realized and unrealized gain (loss) on investments .......     $ 13,949      $ 15,622      $ 13,220
  Adjustments to reconcile net operating income and realized and unrealized gain
    (loss) on investments to net cash provided by operating activities:
        Loans funded, held for sale .................................................       (7,407)      (20,622)      (21,915)
        Proceeds from sale of guaranteed loans ......................................        9,978        21,638        19,988
        Change in unrealized depreciation on investments and loans written-off ......          199           543           182
        Unrealized premium income, net ..............................................           (7)          215            (5)
        Depreciation and amortization ...............................................        1,340         1,032         1,084
        Accretion of loan discount and deferred fees ................................       (1,163)       (1,623)         (957)
        Deferred fees collected .....................................................           91           766           785
        Gain on sale of assets, net .................................................         (928)       (2,360)           -- 
        Equity in income of unconsolidated subsidiaries, net ........................       (2,624)       (2,560)         (369)
        Net change in operating assets and liabilities:
            Accrued interest receivable .............................................           29          (231)          347
            Other assets ............................................................          338          (527)          357
            Accrued interest payable ................................................          (52)         (127)            8
            Borrower advances .......................................................          (81)         (116)         (465)
            Other liabilities .......................................................       (1,610)       (1,069)        1,812
                                                                                          --------      --------      --------
NET CASH PROVIDED BY OPERATING ACTIVITIES ...........................................       12,052        10,581        14,072
                                                                                          --------      --------      --------
CASH FLOWS FROM INVESTING ACTIVITIES:
  Loans funded ......................................................................      (59,043)      (65,739)      (48,239)
  Principal collected and other adjustments .........................................       24,661        10,069        22,647
  Proceeds from interest-only strip receivables .....................................          792           648            -- 
  Purchase of furniture and fixtures and other assets ...............................         (146)         (139)         (127)
  Purchase of mortgage-backed security of affiliate .................................       (2,168)           --            -- 
  Proceeds from sale of assets ......................................................          301        22,986            -- 
  Proceeds from partnership distributions ...........................................        3,012         3,347            -- 
  Release of (investment in) restricted cash ........................................          273        (1,569)          556
   Advances from (to) unconsolidated affiliates, net ................................       (1,555)       (1,004)        1,114
  Investment in unconsolidated subsidiaries .........................................       (3,253)           --          (893)
                                                                                          --------      --------      --------
NET CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES .................................      (37,126)      (31,401)      (24,942)
                                                                                          --------      --------      --------

CASH FLOWS FROM FINANCING ACTIVITIES:
   Proceeds from issuance or assumption of SBA debentures ...........................           --            --           941
   Proceeds from issuance of common stock ...........................................        2,061         5,475         2,834
   Proceeds from unconsolidated subsidiary ..........................................       40,876            --        37,803
   Payment of dividends on common stock .............................................      (14,771)      (13,197)      (11,935)
   Payment of dividends on preferred stock ..........................................         (250)         (250)         (250)
   Payment of SBA debentures ........................................................       (1,500)       (3,280)           -- 
   Payment of issuance costs on notes and debentures ................................         (119)         (443)          (80)
                                                                                          --------      --------      --------
NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES .................................       26,297       (11,695)       29,313
                                                                                          --------      --------      --------

NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS ................................        1,223       (32,515)       18,443

CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR ........................................       17,502        50,017        31,574
                                                                                          --------      --------      --------

CASH AND CASH EQUIVALENTS, END OF YEAR ..............................................     $ 18,725      $ 17,502      $ 50,017
                                                                                          ========      ========      ========

SUPPLEMENTAL DISCLOSURE:
   Interest paid ....................................................................     $  5,474      $  5,631      $  5,433
                                                                                          ========      ========      ========

   Dividends reinvested .............................................................     $    700      $    963      $    880
                                                                                          ========      ========      ========

   Loans receivable acquired in exchange for SBA debentures .........................     $     --      $     --      $    158
                                                                                          ========      ========      ========

   Reclassification from loans receivable to real property owned ....................     $    109      $    203      $    453
                                                                                          ========      ========      ========

   Loans to facilitate sale of real property owned ..................................     $     73      $     --      $     -- 
                                                                                          ========      ========      ========

   Loans contributed to unconsolidated subsidiary, net ..............................     $ 43,144      $     --      $ 45,145
                                                                                          ========      ========      ========
</TABLE>


              THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE
                       CONSOLIDATED FINANCIAL STATEMENTS.



                                      F-11

<PAGE>   39

                       PMC CAPITAL, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:

BUSINESS

PMC Capital, Inc. ("PMC Capital" or "PMC" and, together with its subsidiaries,
the "Company") is a diversified closed-end management investment company that
operates as a business development company ("BDC") under the Investment Company
Act of 1940, as amended (the "1940 Act"). The common stock of the Company (the
"Common Stock") is traded on the American Stock Exchange under the symbol
"PMC." PMC Capital has elected to be taxed as a regulated investment company
under the Internal Revenue Code and distributes substantially all its taxable
income as dividends to its shareholders, thereby incurring no Federal income
tax liability on such income.

The Company primarily engages in the business of originating loans to small
businesses either directly or through its three principal subsidiaries: First
Western SBLC, Inc. ("First Western"), PMC Investment Corporation ("PMCIC") and
Western Financial Capital Corporation ("Western Financial"). The Company
primarily originates loans to individuals and small business concerns in the
lodging industry. The Company also targets the medical, food service, service,
retail and commercial real estate industries. The Company is a national lender
that primarily lends to businesses in the Southwest and Southeast regions of
the United States. A majority of the Company's loans in the lodging industry
are to owner-operated facilities generally operating under national franchises.
The Company believes that franchise operations offer attractive lending
opportunities because such businesses employ proven business concepts, have
national reservation systems, have consistent product quality, are screened and
monitored by franchisors and generally have a higher rate of success as
compared to other independently operated businesses. In addition to the
Company's lending operations, it earns revenue as an investment advisor who
evaluates and services loans and other investment alternatives pursuant to a
fee arrangement with PMC Commercial Trust ("PMC Commercial"). PMC Commercial is
a real estate investment trust and an affiliate of the Company.

PMC Capital, incorporated in Florida under the name of Pro-Med Capital, Inc. in
June 1983, became the successor by merger to Western Capital Corporation
(founded in 1979) in December 1983 and changed its name to "PMC Capital, Inc."
in March 1991. First Western, PMCIC and Western Financial are registered under
the 1940 Act as diversified closed-end management investment companies. In
addition, PMC Capital is either directly or indirectly the sole shareholder or
partner of several non- investment company act subsidiaries. These are: PMC
Advisers, Ltd. and its subsidiary ("PMC Advisers"); PMC Funding Corp. and its
subsidiary ("PMC Funding"); PMC Capital Limited Partnership (the "96
Partnership") and its related general partner and trust; and PMC Capital, L.P.
1998-1 and its related general partner (the "98 Partnership" and together with
the 1996 Partnership, the "Limited Partnerships").

PRINCIPLES OF CONSOLIDATION

The consolidated financial statements include the accounts of PMC and its
wholly owned regulated investment company subsidiaries (collectively, the
"Company"). Intercompany transactions have been eliminated in consolidation.

The accounts of PMC Advisers, PMC Funding and the Limited Partnerships are
accounted for by the equity method of accounting in conformity with Federal
securities laws.

CONSOLIDATED SUBSIDIARIES

First Western is a small business lending company ("SBLC") that originates
variable-rate loans which are partially guaranteed by the Small Business
Administration ("SBA") pursuant to its Section SBA 7(a) Program (the "SBA 7(a)
Program"). The eligibility requirements of the SBA 7(a) Program vary by the
industry of the borrower and other factors.

PMCIC is a licensed specialized small business investment company ("SSBIC")
under the Small Business Investment Act of 1958, as amended ("SBIA"). PMCIC
uses long-term funds provided by the SBA, together with its own capital, to
provide long-term collateralized loans to eligible small businesses owned by
"disadvantaged" persons, as defined under the regulations of the SBA. The
interest rates on loans originated by PMCIC are either fixed or variable based
on the prime lending rate ("Prime Rate"). As an SSBIC, PMCIC is eligible to
obtain long-term, fixed-rate, funding from the SBA through the issuance of
debentures (which are guaranteed by the SBA and on which the interest rate is
being reduced through an SBA subsidy by 3% during the first five years) and
preferred stock.

Western Financial is a licensed small business investment company ("SBIC")
under the SBIA that provides long-term loans to borrowers whether or not they
qualify as "disadvantaged". The interest rates on loans originated by Western
Financial are either fixed or variable based on the Prime Rate. As an SBIC,
Western Financial is eligible to obtain long-term, fixed-rate, funding from the
SBA through the issuance of debentures.


                                     F-12
<PAGE>   40

                       PMC CAPITAL, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: (CONTINUED)

PMC originates loans to borrowers on a non-SBA supported basis using similar
criteria as that used for other loans that are funded under the SBA programs
utilized by the subsidiaries. These loans are made to borrowers who exceed the
eligibility requirements of the SBA 7(a) Program or SBIC programs.

UNCONSOLIDATED ENTITIES

PMC Advisers acts as the investment advisor for PMC Commercial, a Texas real
estate investment trust and an affiliate of PMC Capital.

PMC Funding is a Florida corporation that holds assets on behalf of the
Company. PMC Capital is the sole shareholder of PMC Funding.

The 1996 Partnership was formed as a Delaware limited partnership in November
1996 to act as a special purpose affiliate of the Company. The 1996 Partnership
was established to acquire loans from the Company and to issue fixed-rate debt
through a private placement. PMC Capital Corp. is a Delaware corporation formed
in November 1996 to be the independent trustee of the general partner of the
Partnership. PMC Trust 1996-A is a Delaware business trust formed in November
1996 to be the general partner of the Partnership.

The 1998 Partnership was formed as a Delaware limited partnership in November
1998 to act as a special purpose affiliate of the Company. The 1998 Partnership
was established to acquire loans from the Company and to issue fixed-rate debt
through a private placement. PMC Capital Corp. 1998-1 is a Delaware corporation
formed in November 1998 to be the general partner of the 1998 Partnership.

USE OF ESTIMATES IN THE PREPARATION OF FINANCIAL STATEMENTS

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

VALUATION OF INVESTMENTS

Loans Receivable: Loans receivable are carried at the Board of Directors'
estimate of fair value. The Board of Directors has estimated the fair value of
loans receivable to approximate the amortized costs of the loans, unless there
is doubt as to the realization of the loan (a "Problem Loan"). A valuation
reserve is established for a Problem Loan based on the creditor's payment
history, collateral value, guarantor support and other factors.

Loans, including impaired loans, are generally classified as non-accrual if
they are past due as to maturity or payment of principal or interest for a
period of more than 60 days. If a loan or a portion of a loan is classified as
doubtful or is partially reserved or charged-off, the loan is classified as
non-accrual. Loans that are on a current payment status or past due less than
60 days may also be classified as non-accrual if repayment in full of principal
and/or interest is in doubt.

When selling the SBA-guaranteed portion of loans, the basis of the retained
portion of the loans has been reduced by the differential between the face
amount of the unguaranteed portion of the loans and the value as determined in
accordance with the Financial Accounting Standards Board ("FASB") Emerging
Issues Task Force ("EITF") 88-11. This difference being the Retained Loan
Discount. At the time of sale, premium income has been reduced by the Retained
Loan Discount. Unless the underlying loans are paid in full or sold, the
Retained Loan Discount is amortized over the life of the underlying loan based
on an effective yield method. When a loan is prepaid, the remaining Retained
Loan Discount is recognized as an increase to interest income. When a loan is
sold, the remaining Retained Loan Discount is included as a reduction to the
basis of the retained portion of the underlying loan as a reduction of cost.

Deferred fees consist of non-refundable fees less direct loan origination
costs. For loans originated prior to January 1, 1998, these fees are being
recognized over the expected life of the related loan. For loans originated
subsequent to December 31, 1997 these fees are being recognized currently. The
change did not materially impact the Company's financial statements.


                                     F-13
<PAGE>   41

                       PMC CAPITAL, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: (CONTINUED)

Interest-only Strip Receivable and Servicing Asset: Effective January 1, 1997,
the Company adopted Statement of Financial Accounting Standards ("SFAS") No.
125, "Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities." SFAS No. 125 provides for the accounting and
reporting of transfers and servicing of financial assets based on a
financial-components approach.

The transfer of assets that qualifies for sale treatment under SFAS No. 125 is
generally accounted for by the seller by: (i) derecognizing all assets sold,
(ii) recognizing all assets obtained and liabilities incurred at their relative
fair value, and (iii) recognizing all assets retained at their allocated
previous carrying amount based on relative fair values. The Company typically
receives cash and retains the right to receive contractual servicing fees and
the right to receive future interest income on loans sold that exceed the
contractually specified servicing fee (the interest-only strip receivable) in
exchange for a portion of the loan, typically the guaranteed portion of an SBA
7(a) loan. The difference between (i) the carrying value of the portion of
loans sold and (ii) the sum of (a) cash received, (b) the relative fair values
of the servicing rights and (c) the interest-only strip receivable retained,
constitutes the gain on sale.

In accordance with SFAS No. 125, the Company establishes a servicing asset to
the extent the Company receives contractual compensation for servicing loans
which is in excess of the cost of servicing these loans. Servicing the sold
portion of government guaranteed loans requires First Western to retain a
minimum servicing spread of 1%. This spread is in excess of the costs
associated with servicing these loans. Accordingly, the Company has recorded a
servicing asset relating to the servicing of the sold portion of First
Western's loans. The servicing asset is amortized in proportion to and over the
period of estimated net servicing income and is evaluated for impairment by
stratifying the servicing assets by one or more of the predominant risk
characteristics of the underlying financial assets.

The interest-only strip receivable is accounted for as an investment in debt
securities classified as available for sale under SFAS No. 115. As of the date
a securitization is completed, an asset is established and classified as an
"interest-only strip receivable". This receivable is initially valued based on
management's estimate of the anticipated discounted future cash flows retained
by the Company related to the pool of securitized loans. The discount rate is a
market rate based on interest rate levels at the time of completion of the
transaction considering the risks inherent in the transaction.

On a quarterly basis thereafter, income generated by the interest-only strip
receivable is recognized based on an "internal rate of return" (the "IRR")
which during the initial reporting period after completion of the
securitization is the market rate used in valuing the interest-only strip
receivable. Management updates the anticipated future cash flows on a quarterly
basis and determines an updated IRR based on the recorded interest-only strip
receivable during the following quarter. If during any evaluation of the value
of the interest-only strip receivable it is determined that the IRR is lower
than a "risk free" rate for an asset of similar duration, a realized loss will
be incurred which adjusts the recorded value of the interest-only strip
receivable to the market value.

In addition, on a quarterly basis, the Company measures the fair value of the
interest-only strip receivable based upon the future anticipated cash flows
discounted to reflect the current market interest rates for investments of this
type. Any appreciation (depreciation) of the interest-only strip receivable is
reflected on the accompanying consolidated statements of income as an
unrealized gain (loss) on investment. As of December 31, 1998 and 1997, there
was an unrealized loss of $180,000 and $300,000, respectively, related to the
interest-only strip receivable. During the years ended December 31, 1998 and
1997, the Company recorded an unrealized gain of $120,000 and an unrealized
loss of $300,000 relating to the interest-only strip receivable.

The estimated net servicing income and the investment in the interest-only
strip receivable are based in part upon management's estimate of prepayment
speeds, including default rates. There can be no assurance of the accuracy of
these estimates. If the prepayment speeds occur at a faster rate than
anticipated, the amortization of the servicing asset will be accelerated and
the value of the interest-only strip receivable will decline, accordingly total
income during the period of change and subsequent periods would be reduced. If
prepayments occur slower than anticipated, cash flows would exceed estimated
amounts and total income during the period of change and subsequent periods
would be enhanced.

Real Property Owned: Real property owned is carried at the Board of Directors'
estimate of fair value, based upon appraisals and other factors.


                                     F-14
<PAGE>   42

                       PMC CAPITAL, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: (CONTINUED)

Mortgage-Backed Security of Affiliate: The Mortgage-backed security represents
the ownership of the Class B notes of the 1998 Partnership and is valued at
amortized cost which approximates fair value.

Cash equivalents: Cash equivalents are carried at value, which approximates
cost.

VALUATION OF DEBT

Debt incurred by the Company is valued at cost.

PROPERTY AND EQUIPMENT

Property, equipment and leasehold improvements are carried at their value,
which is cost less accumulated depreciation and amortization. Depreciation and
amortization are computed using accelerated and straight-line methods, with
estimated useful lives ranging from five to 15 years.

NET UNREALIZED DEPRECIATION ON INVESTMENTS

Included in net unrealized depreciation on investments is valuation allowances
for loans receivable and the interest-only strip receivables.

REALIZED AND UNREALIZED GAIN (LOSS) ON INVESTMENTS

Realized gains or losses are measured by the difference between the proceeds
from the sale and the cost basis of the investment, without regard to
unrealized gains and losses previously recognized. The gain or loss calculated
also includes loans written-off or charged-down during the year and recoveries
of loans written-off or charged-down in prior years.

Other changes in the value of investments are included as changes in the
unrealized appreciation (depreciation) on investments in the statements of
income.

Realized gains on the sale of loans are recognized based upon the difference
between the sales price as adjusted for the value of the anticipated future
cash values (as reduced by the effect of future credit losses) and the carrying
value of the assets (including the Retained Loan Discount, if any).

INTEREST INCOME

Interest income includes income on loans and the yield on the interest-only
strip receivables. Interest income on loans is accrued as earned and the
accrual of interest is generally suspended when the related loan becomes 60
days past due (a "Non-accrual Loan"). Interest income on a Non-accrual Loan is
recognized on the cash basis.

PREMIUM INCOME

For loans originated by the SBLC, gain on the sale of the SBA guaranteed
portion of such loans to the secondary market has been adjusted to reflect a
normal service fee for the future servicing rights retained by the Company.
Premium income represents the differential between the value attributable to
the sale of a loan to the secondary market and the principal balance (cost) of
the loan in accordance with EITF 88-11. The sale price includes the value
attributable to any excess servicing spread retained by the Company plus any
cash received.

DEFERRED CHARGES

Costs incurred in connection with the issuance of SBA debentures and notes
payable are included in deferred charges, deposits and other assets. These
costs are amortized over the life of the related obligation.

FEDERAL INCOME TAXES

The Company has elected to be treated as a regulated investment company by
meeting certain requirements of the Internal Revenue Code relating to the
distribution of its net investment income to shareholders. Thereby the Company
incurs no Federal income tax liability on such income. Based on its status as a
regulated investment company, the Company may elect to retain, deem to
distribute or distribute, in whole or in part, net long-term capital gains
realized on the disposition of its investments.

Any dividends declared by the Company in October, November or December of any
calendar year, payable to shareholders of record on a specified date in such
month and actually paid during January of the following year, may be treated as
if it were received by the shareholders on December 31 of the year declared.


                                     F-15
<PAGE>   43

                       PMC CAPITAL, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: (CONTINUED)

DISTRIBUTIONS TO SHAREHOLDERS

Distributions to shareholders are recorded on the ex-dividend date.

STATEMENT OF CASH FLOWS

The Company considers all highly liquid investments purchased with an original
maturity of three months or less to be cash equivalents for purposes of the
consolidated statement of cash flows.

RECLASSIFICATION

Certain prior period amounts have been reclassified to conform to current year
presentation.

NOTE 2. LOANS RECEIVABLE:

Loans receivable consist primarily of loans made under SBIC, SSBIC and SBLC
programs established by the SBA and financings to businesses outside of the SBA
loan programs.

As an SBLC, First Western originates loans which are partially guaranteed by
the SBA and which are collateralized generally, with first liens on real and/or
personal property of the borrower. The SBA guarantees repayment of up to 80% of
the principal amount of the loans originated by First Western. First Western
sells, without recourse, the guaranteed portion of its loans into the secondary
market ("SBA Guaranteed Sales") while retaining the rights to service the
loans. Funding for the SBA 7(a) Program depends on the annual appropriations by
the U.S. Congress. At December 31, 1998, included in loans receivable are
approximately $2.4 million which represents the guaranteed portion of First
Western loans available for sale.

The principal balance of the loans serviced on behalf of third parties by First
Western was approximately $105.8 million and $133.7 million at December 31,
1998 and 1997, respectively.

First Western's loans: (i) generally range in original principal amount from
$50,000 to $1,100,000, (ii) provide for a variable rate of interest based on
1.0% to 2.75% above the then prevailing prime rate, (iii) have a term of seven
to 25 years, (iv) may be prepaid without penalty and (v) require monthly
payments covering accrued interest and amortization of principal based in part
on the remaining useful life of the assets collateralizing the loans and on the
borrowers' use of loan proceeds.

PMCIC and Western Financial originate loans that are payable in monthly
installments of principal and interest based upon five to 20 year amortization
periods, with the balance due at maturity. These loans are collateralized with
first liens on real and/or personal property and are generally guaranteed by
the principals of the borrower.

PMC originates loans to borrowers on a non-SBA supported basis, using similar
criteria for loans that are funded under the SBA programs utilized by its three
principal subsidiaries. These loans are: (i) to borrowers who exceed the
eligibility requirements of the SBA 7(a) Program or SBIC programs, (ii) payable
in monthly installments of principal and interest based upon four to 25 year
amortization periods, with the balance due at maturity, (iii) generally
collateralized by real estate and/or equipment, (iv) contain prepayment fees
and (iv) are generally guaranteed by the principals of the borrower.

The Company's portfolio of investments consists of loans to borrowers located
principally in the southern portion of the United States. The most significant
concentration of retained loans were to borrowers in Texas, California, Florida
and Georgia, as noted below:

<TABLE>
<CAPTION>
                                            Percentage of Loan Portfolio
           State                                     December 31,
           -----                            ----------------------------
                                                  1998         1997  
                                            ----------------------------
           <S>                              <C>             <C>
           Texas                                   35%          33%
           California                               8%           8%
           Florida                                  6%           4%
           Georgia                                  4%           9%
           Other                                   47%          46%
                                                 ----         ---- 
                                                  100%         100%
                                                 ====         ====
</TABLE>


                                     F-16
<PAGE>   44

                       PMC CAPITAL, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


NOTE 2. LOANS RECEIVABLE: (CONTINUED)

The activity in net unrealized depreciation on loans receivable is as follows:

<TABLE>
<CAPTION>
                                                           Years Ended December 31,   
                                                         ----------------------------
                                                            1998              1997
                                                         ----------        ----------
    <S>                                                  <C>               <C>      
    Balance, beginning of period...................      $ 494,000         $ 435,000
    Provision for losses...........................        319,000           242,000
    Loans written-off..............................       (219,000)         (183,000)
                                                         ---------         ---------
    Balance, end of period.........................      $ 594,000         $ 494,000
                                                         =========         =========
</TABLE>

Loans receivable with an aggregate retained balance of $1.6 million and $1.5
million were greater than 60 days past due, litigation against the borrowers
has commenced, or the loans are in the process of liquidation at December 31,
1998 and 1997, respectively.

At December 31, 1998 and 1997, the recorded investment in loans identified as
impaired in accordance with SFAS No. 114 totaled $1.8 million and $3.1 million,
respectively. Of this total, at December 31, 1998 and 1997, approximately
$600,000 and $1.9 million, respectively, related to loans with no valuation
reserve, since the estimated fair value of the collateral for each loan exceeds
the respective loan balance. Approximately $1.3 million and $1.2 million of
these loans at December 31, 1998 and 1997, have a corresponding valuation
allowance of $588,000 and $472,000, respectively. At December 31, 1998 and
1997, the Company has recognized $6,000 and $22,000 in valuation allowances on
identified problem loans of $44,000 and $95,000, respectively, which were not
deemed impaired. The Company did not recognize any material amount of interest
on impaired loans during the portion of the period that they were impaired. Had
these impaired loans performed in accordance with their original terms,
interest income of approximately $180,000 and $264,000, respectively, would
have been recognized during the years ended December 31, 1998 and 1997.

In addition to the SBA Guaranteed Sales, First Western sells through separate
transactions, the unguaranteed portion of certain of its originated loans
through private placements ("SBA Unguaranteed Sales"). First Western retains
the right to service all such loans. The guaranteed portions are sold to either
dealers in government guaranteed loans or institutional investors and certain
of the unguaranteed portions have been sold in privately negotiated
transactions between First Western and the purchasers.

During the year ended December 31, 1996, PMC Capital contributed approximately
$45.7 million (aggregate principal balance due, including $34.4 million in
loans transferred from PMCIC and Western Financial to PMC Capital) of loans to
the 1996 Partnership without recourse (see Note 15). At December 31, 1998, the
remaining principal balance outstanding on those loans was $16.1 million.

During November 1998, PMC Capital contributed approximately $43 million
(aggregate of principal balance, including $22.3 million in loans transferred
from PMCIC and Western Financial to PMC Capital) of loans to the 1998
Partnership without recourse (see Note 15). At December 31, 1998, the remaining
principal balance outstanding on those loans was $41.3 million.

NOTE 3. SERVICING ASSET AND PREMIUM INCOME:

By retaining the right to service the loan, First Western earns an interest
rate spread equal to the difference between the interest rate on the loan and
the interest rate paid to the purchaser on the sold portion (this difference
being the "Servicing Spread"). On SBA Guaranteed Sales, First Western or PMC
recognizes premium income by receiving either a cash premium, an excess
servicing right on the sale or a combination of these elements. On SBA
Guaranteed Sales that involve receiving the maximum premium, First Western
retains the minimum Servicing Spread of 1% required by SBA regulations ("SBA
Minimum Servicing"). When receiving the maximum premium, PMC or First Western
recognizes as premium income the difference between the amount received from
the purchaser and the aggregate of the outstanding principal amount of the
guaranteed portion plus any value of the Servicing Spread in excess of normal
servicing fees (the "Excess Servicing Spread").

On SBA Guaranteed Sales, First Western recognizes premium income equal to the
value of the Excess Servicing Spread, plus the difference, if any, between the
amount received from the purchaser and the outstanding principal amount of the
guaranteed portion sold as valued in accordance with EITF 88-11.


                                     F-17
<PAGE>   45
                       PMC CAPITAL, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


NOTE 3. SERVICING ASSET AND PREMIUM INCOME: (CONTINUED)

The Board of Directors estimates the value of the Excess Servicing Spread based
upon various factors including premiums realized on comparable transactions in
the secondary market with a 1% servicing fee being retained, comparable market
bids with normal servicing rates on SBA loans and the likelihood of prepayment.
The value of the Excess Servicing Spread is recognized as premium income at the
time of the sale and is concurrently capitalized as an asset on the Company's
balance sheet as the Servicing Asset and the interest only strip receivable.

The activity in the servicing asset is summarized as follows:

<TABLE>
<CAPTION>
                                                            Years Ended December 31,
                                                  --------------------------------------------
                                                      1998            1997            1996
                                                  ------------    ------------    ------------
<S>                                               <C>             <C>             <C>         
Aggregate balance, beginning of year..........    $  1,607,000    $  1,753,000    $  7,514,000
Aggregate additions, net of allowances........         222,000         328,000         707,000
Amortization, net.............................        (499,000)       (474,000)     (1,792,000)
                                                  ------------    ------------    ------------
                                                     1,330,000       1,607,000       6,429,000
Reclassifications pursuant to SFAS No. 125,
Valuation reserves............................            --              --        (1,533,000)
Allocation to interest-only strip
receivables...................................            --              --        (3,143,000)
                                                  ------------    ------------    ------------
Aggregate balance, end of year................    $  1,330,000    $  1,607,000    $  1,753,000
                                                  ============    ============    ============
</TABLE>

NOTE 4. PROPERTY AND EQUIPMENT:

At December 31, 1998 and 1997, property and equipment consisted of the
following:

<TABLE>
<CAPTION>
                                                         1998            1997     
                                                     ------------    ------------
<S>                                                  <C>             <C>         
Furniture and equipment ..........................   $    536,000    $    392,000
Leasehold improvements ...........................           --           150,000
Automobiles ......................................         13,000          13,000
                                                     ------------    ------------
                                                          549,000         555,000
Less:accumulated depreciation ....................        321,000         318,000
                                                     ------------    ------------
                                                     $    228,000    $    237,000
                                                     ============    ============
</TABLE>

Depreciation and amortization expense for the years ended December 31, 1998,
1997 and 1996 was approximately $151,000, $59,000 and $49,000, respectively.
Included in amortization is approximately $89,000 during the year ended
December 31, 1998 relating to the write-off of leasehold improvements relating
to the previously occupied leased office space. The lease was terminated on
January 1, 1999.

NOTE 5. NOTES PAYABLE:

PMC has a $15 million uncollateralized revolving credit facility which expires
May 2000. Advances pursuant to the credit facility bear interest at the
Company's option at the bank's prime rate less 50 basis points or the London
Interbank Offering Rate (LIBOR) plus 175 basis points. The credit facility
requires the Company to meet certain covenants, the most restrictive of which
requires that the ratio of net charge-offs to net loans receivable will not
exceed 2%, and the ratio of assets to senior debt (as defined in the note
agreement) will not fall below 135%, as amended. At December 31, 1998 and 1997,
the Company had no amounts outstanding pursuant to this credit facility and the
Company was in compliance with all covenants of this facility. PMC has $35
million in outstanding debt pursuant to private placements of uncollateralized
notes. These borrowings have been utilized to fund commitments of the non-SBA
lending program. The notes require the Company to meet certain covenants (terms
are as defined in the applicable note agreement), the most restrictive of which
require; (i) that net loans receivable exceed 150% of senior funded debt, (ii)
the increase in the Company's loan valuation reserve for any 12 month period
must not exceed 3% of net loans receivable and (iii) the Company's consolidated
earnings plus interest expense must exceed 150% of interest expense. At
December 31, 1998, the Company was in compliance with all of the covenants of
these


                                     F-18
<PAGE>   46

                       PMC CAPITAL, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


NOTE 5. NOTES PAYABLE: (CONTINUED)

notes. At December 31, 1998 and 1997 outstanding uncollateralized notes were as
follows:

<TABLE>
<CAPTION>
                                       Interest                                        Final
                  Date                   Rate                  Amount                 Maturity
            -----------------       --------------         --------------        -----------------
            <S>                     <C>                    <C>                   <C>
              July 19, 1993               7.20%            $20,000,000(2)         July 19, 2001
            December 15, 1993             6.97%              5,000,000           December 15, 2002
              April 19, 1995              8.60%              5,000,000            April 19, 2003
              April 19, 1995        LIBOR +1.3%(1)           5,000,000            April 19, 2004
                                                           -----------
                                                           $35,000,000
                                                           ===========
</TABLE>

         (1)      Reset quarterly, 6.52% at December 31, 1998.
         (2)      Payable in three equal annual installments commencing July
                  19, 1999.

         Principal payments required on the notes at December 31, 1998, are as
follows:

<TABLE>
<CAPTION>
                      Year Ending
                      December 31,                Amount   
                      ------------            ------------
                      <S>                     <C>         
                        1999                  $  6,666,667
                        2000                     6,666,667
                        2001                     6,666,666
                        2002                     5,000,000
                        2003                     5,000,000
                        2004                     5,000,000 
                                              ------------ 
                                              $ 35,000,000
                                              ============
</TABLE>

NOTE 6. SBA DEBENTURES PAYABLE:

Debentures payable represent amounts due to the SBA as a result of borrowing
made pursuant to the SBIA.

At December 31, 1998, the maturities, interest rates and principal payments on
the SBA debentures were as follows:

<TABLE>
<CAPTION>
           Maturity Date (1)           Interest Rate            Amount  
           -----------------           -------------        ------------
           <S>                         <C>                  <C>       
           August 18, 1999                  8.125%          $ 1,000,000
           September 1, 1999                8.800%            2,500,000
           December 1, 1999             (2) 8.600%              650,000
           January 2, 2000                  7.875%            3,000,000
           March 1, 2000                    9.350%            1,000,000
           June 1, 2000                 (2) 9.300%              300,000
           June 1, 2000                     9.300%            2,000,000
           June 1, 2000                 (3) 9.300%            1,030,000
           September 1, 2000                9.600%            4,310,000
           December 1, 2002             (2) 7.510%              510,000
           September 1, 2004            (4) 5.200%            3,000,000
           September 1, 2004                8.200%            3,000,000
           March 1, 2005                (5) 4.840%            3,000,000
           June 1, 2005                 (6) 3.690%            5,000,000
           September 1, 2005            (7) 3.875%            7,000,000
           September 1, 2006                7.590%            2,490,000
                                                            -----------
                                                            $39,790,000
                                                            ===========
</TABLE>

         (1)      During the year ended December 31, 1998 and 1997, the Company
                  paid off $1,500,000 and $3,280,000, respectively, in
                  debentures payable at their maturity. Total debentures
                  outstanding at December 31, 1997 were $41,290,000.

         (2)      During April 1995, the Company assumed $2,260,000 in SBA
                  debentures from a non-affiliated small business investment
                  corporation in exchange for loans receivable of $2,109,062
                  and cash of $150,938.


                                     F-19
<PAGE>   47

                       PMC CAPITAL, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


NOTE 6. SBA DEBENTURES PAYABLE: (CONTINUED)

                  The loans acquired were initially originated by the Company
                  and a portion sold to the non-affiliated small business
                  investment corporation. All of these loans were purchased at
                  par and were performing according to their terms at the time
                  of reacquisition.

         (3)      During May 1996, the Company assumed $1,030,000 in SBA
                  debentures from a non-affiliated SBIC in exchange for loans
                  receivable of approximately $200,000 and cash of
                  approximately $900,000. The loans acquired were initially
                  originated by the Company and a portion sold to the
                  non-affiliated SBIC.

                  All of these loans were purchased at par and were performing
                  according to their terms at the time of reacquisition.

         (4)      The interest rate will increase to 8.200% in September 1999
                  until maturity.

         (5)      The interest rate will increase to 7.840% in March 2000 until
                  maturity.

         (6)      The interest rate will increase to 6.690% in June 2000 until
                  maturity.

         (7)      The interest rate will increase to 6.875% in September 2000
                  until maturity.

NOTE 7. COMMITMENTS AND CONTINGENCIES:

OPERATING LEASES

During 1991, the Company entered into an agreement to lease its corporate
office space for a 15 year period from a corporation, a majority of whose
principals are officers and directors of the Company. Leasehold improvements of
$150,000 were paid to the corporation for costs incurred during the build-out
of the leased premises. The lease had been amended to allow the Company to
terminate such lease without penalty upon 60 days written notice to the
corporation. During September 1998, the Company exercised the option to
terminate the Lease effective January 1, 1999.

In September 1998, the Company entered into a five year lease for office space
commencing December, 1998. The Company may at its option, renew the term of the
lease for two additional five year periods. At December 31, 1998, the Company
has additional agreements to lease office space in Phoenix, Arizona; and
Atlanta, Georgia. Rental expense amounted to approximately $244,000, $229,000
and $213,000 during the years ended December 31, 1998, 1997 and 1996,
respectively.

Future minimum lease payments at December 31, 1998 are as follows:

<TABLE>
<CAPTION>
                      Year Ending
                      December 31,                      Amount
                      ------------                    ----------
                      <S>                             <C>       
                          1999                        $  284,000
                          2000                           284,000
                          2001                           284,000
                          2002                           284,000
                          2003                           284,000
                       Thereafter                         24,000
                                                      ----------
                                                      $1,444,000
                                                      ==========
</TABLE>

LOAN COMMITMENTS

Loan commitments outstanding at December 31, 1998, to various prospective small
business companies, including the unfunded portion of projects in the
construction phase, amounted to approximately $57.3 million. Of these
commitments, $16.7 million are for loans to be originated by First Western, a
portion of which will be sold pursuant to SBA Guaranteed Sales. These
commitments are made in the ordinary course of the Company's business and in
management's opinion, are generally on the same terms as those to existing
borrowers. Commitments to extend credit are agreements to lend to a customer
provided that the terms established in the contract are met.
Commitments generally have fixed expiration dates and require
payment of a fee. Since some commitments are expected to expire without being
drawn upon, the total commitment amounts do not necessarily represent future
cash requirements.


                                     F-20
<PAGE>   48

                       PMC CAPITAL, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


NOTE 7. COMMITMENTS AND CONTINGENCIES: (CONTINUED)

EMPLOYMENT AGREEMENTS

The Company has employment contracts with certain of its officers and/or
employees for terms expiring June 2001. Annual remuneration during the term of
the contracts do not exceed $315,000 for any one individual. Future minimum
payments under these contracts are as follows:

<TABLE>
<CAPTION>
                      Year Ending
                      December 31,                      Amount
                      ------------                    ----------
                      <S>                             <C>       
                          1999                        $1,442,000
                          2000                         1,442,000
                          2001                           721,000
                                                      ----------
                                                      $3,605,000
                                                      ==========
</TABLE>

During the years ended December 31, 1998, 1997 and 1996 compensation to
officers was approximately $1,503,000, $1,639,000 and $1,382,000, respectively.

LITIGATION

In the normal course of business, the Company is subject to various proceedings
and claims, the resolution of which will not, in management's opinion, have a
material adverse effect on the Company's consolidated financial position or
results of operations.

NOTE 8. CREDIT AND INTEREST RATE RISK:

In connection with First Western's structured sales of the unguaranteed portion
of SBA loans and the structured sale of loans during 1998, the Company is
subject to credit risk. Pursuant to the structured sales, the investors'
protection from losses is provided by: (i) the subordination of the Company's
right to receive payment on loans receivable (aggregating approximately
$443,000 at December 31, 1998), (ii) the subordination of the interest-only
strip receivable related to the Company's right to receive the Servicing Spread
on those loans sold in the securitizations (valued at $2,691,000 at December
31, 1998, included in interest-only strip receivable on the accompanying
balance sheet) and (iii) the subordination of Class B certificate held by PMC
Capital with a value of approximately $2.2 million, (iv) the investment in the
1998 Partnership with a value of $5.5 million and (v) cash deposits provided by
the Company. At December 31, 1998, approximately $2.3 million of cash deposits
held by the Company in interest bearing accounts were restricted.

Impairment of the interest-only strip receivable is measured based on its fair
value. In measuring impairment at December 31, 1998 and 1997, the servicing
portfolio was evaluated based upon the predominant risk characteristics which
the Company has determined to be prepayment and payment default risks. The
Company evaluated the serviced portfolio for both the interest-only strip
receivable related to SBA Guaranteed Sales, the sale of the unguaranteed
portion of SBA loans in 1994 and 1997 (the "SBA Unguaranteed Sales") and the
structured sale in 1998. Based upon current prepayment assumptions, estimates
of default rates and a discount factor considering the current interest rate
environment, the Company has recorded an unrealized gain and unrealized loss of
$120,000 and $300,000 during the years ended December 31, 1998 and 1997,
respectively. At December 31, 1998 and 1997, the net unrealized loss related to
the interest-only strip receivables was $180,000 and $300,000, respectively.

In connection with the Company's investment in the Limited Partnerships, all
payments of principal and interest on the loans contributed to the Limited
Partnerships are to be deposited with the respective trustee and are used to
pay the respective noteholders the required monthly principal and interest then
due on the notes pursuant to the respective Trust Indenture (as defined below)
prior to releasing any excess funds to the Limited Partnerships free and clear
of the respective Trust Indenture. The Limited Partnerships' obligations to the
respective noteholders are also collateralized by: (i) the differential between
the outstanding principal balance remaining due on the underlying loans held by
the Limited Partnerships and the balance due the respective noteholders, (ii)
the reserve account established to provide liquidity to the noteholders ( the
"Reserve Account") and (iii) money held in the operating accounts of the
Limited Partnerships to the extent they are restricted pursuant to the terms of
the respective Trust Indenture established by the noteholders, the Company and
the Limited Partnerships (the "Trust Indenture"). The Trust Indenture provides
for several covenants which would require, under certain circumstances, that
the excess cash , after payment of the required principal and interest to the
respective partnership noteholders (the "Excess Cash"), be retained in the
Reserve Account until the covenants are in compliance. Of the assets of the
Limited Partnerships at December 31, 1998, approximately $93,000 was Excess
Cash which was distributed to the Company in January 1999.


                                     F-21
<PAGE>   49

                       PMC CAPITAL, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


NOTE 8. CREDIT AND INTEREST RATE RISK: (CONTINUED)

The Company has a fundamental policy that requires investment of at least 25%
of its total assets in the lodging industry, and allows investment of up to
100% of total assets in this industry. At December 31, 1998 and 1997, loans to
businesses in the lodging industry comprised 61% and 59% of its total assets,
respectively, and 85% and 77% of its loans receivable, net, respectively. There
can be no assurance that the Company will continue to experience the positive
results it has historically achieved from these lending activities or that
market conditions will enable the Company to maintain or increase this level of
loan concentration. Any economic factors that negatively impact the lodging
industry could have a material adverse effect on the business of the Company.
Additionally, loans to businesses located in Texas currently comprise
approximately 35% of the Company's outstanding loan portfolio. A decline in
economic conditions in Texas may adversely affect the Company.

Net income of the Company is effected by the spread between the rate at which
it borrows funds and the rate at which it loans these funds. A significant
portion of the portfolios of PMC Capital, Western Financial and PMCIC have
typically been long-term and at fixed rates and the borrowed funds of these
companies are typically long-term and at fixed rates. PMCIC, Western Financial
and PMC have also originated variable-rate loans which were part of the
structured securitization and sale which was completed in November 1998 with a
variable interest rate. First Western originates variable-rate loans and has
utilized equity capital of PMC Capital and structured sales of loans to obtain
funds necessary to originate loans. If the yield on loans originated by the
Company with funds obtained from borrowings or the issuance of preferred stock
fails to cover the cost of such funds, the Company's cash flow will be reduced.
During periods of changing interest rates, interest rate mismatches could
negatively impact the Company's net income, dividend yield and the market price
of the Common Stock. Most of the fixed-rate loans that the Company originates
have prepayment penalties. At present interest rate levels or if interest rates
continue to decline, the Company may experience significant prepayments. Such
prepayments, as well as scheduled repayments, are likely to be reloaned or
invested at lower rates, which may have an adverse effect on the Company's
ability to maintain dividend distributions at existing levels.

NOTE 9. CUMULATIVE PREFERRED STOCK OF CONSOLIDATED SUBSIDIARY:

PMCIC has outstanding 30,000 shares of $100 par value, 3% cumulative preferred
stock (the "3% Preferred Stock") and 40,000 shares of $100 par value, 4%
cumulative preferred stock (the "4% Preferred Stock"). The 3% Preferred Stock
and the 4% Preferred Stock (collectively the "Preferred Stock") are held by the
SBA pursuant to the SBIA.

PMCIC is entitled to redeem, in whole or in part, the 3% Preferred Stock by
paying 35% of the par value of these securities plus dividends accumulated and
unpaid on the date of redemption. While the 3% Preferred Stock may be redeemed,
redemption is not mandatory. Dividends of approximately $90,000 on the 3%
Preferred Stock were recognized during each of the years ended December 31,
1998, 1997 and 1996.

The 4% Preferred Stock was issued during 1994 ($2,000,000) and 1995
($2,000,000), and must be redeemed at par no later than 15 years from the date
of issuance. Dividends of approximately $160,000 were recognized on the 4%
Preferred Stock during each of the years ended December 31, 1998, 1997 and
1996, respectively.

Neither series of Preferred Stock has any preemptive or conversion rights. The
Preferred Stock provides for a liquidation preference in the amount of $100 per
share plus accrued and unpaid dividends.

NOTE 10. SHAREHOLDERS' EQUITY:

The Company has a dividend reinvestment and cash purchase plan (the Plan) for
up to 1,000,000 shares of common stock. As amended, effective March 1998,
participants in the Plan have the option to reinvest all or a portion of
dividends received plus an optional cash purchase of up to $5,000 per month.
The purchase price of the shares is the average of the high and low price of
the common stock as published for the five trading days immediately prior to
the dividend record date or prior to the optional cash payment purchase date,
whichever is applicable. During the years ended December 31, 1998, 1997 and
1996, the Company issued 198,329; 468,706; and 291,042; shares of common stock
pursuant to the Plan for proceeds (through cash and the reinvestment of
dividends) of approximately $2.8 million; $6.4 million; and $3.7 million,
respectively.


                                     F-22
<PAGE>   50


                       PMC CAPITAL, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


NOTE 11. EARNINGS PER COMMON SHARE COMPUTATIONS:

The computations of basic earnings per common share are based on the weighted
average number of shares outstanding of the Company. For the purposes of
determining the diluted earnings per share, there was no change in the weighted
average shares outstanding for the effect of stock options during the years
ended December 31, 1998 and 1997 since the stock options were anti-dilutive.
Earnings are defined as the net operating income and realized and unrealized
gain (loss) on investments and are reduced by the preferred stock dividend
requirements of PMCIC. Preferred stock dividend requirements were approximately
$250,000 during each of the years ended December 31, 1998, 1997 and 1996. The
weighted average number of shares used in the computations of basis earnings
per common share were 11.8 million, 11.4 million and 11.0 million for the years
ended December 31, 1998, 1997 and 1996, respectively.

NOTE 12. BORROWER ADVANCES:

The Company finances several projects during the construction phase. At
December 31, 1998, the Company was in the process of funding approximately
$18.4 million in construction projects, of which $10.9 million in funding
remained. As part of the monitoring process to verify that the borrowers' cash
equity is utilized for its intended purpose, the Company deposits amounts
received from the borrowers and releases the funds upon presentation of
appropriate supporting documentation. The Company had approximately $1.6
million and $1.7 million in funds held on behalf of borrowers at December 31,
1998 and 1997, respectively, which is included as a liability in the
accompanying consolidated balance sheets.

NOTE 13. PROFIT SHARING PLAN:

The Company has a profit sharing plan available to its full-time employees
after one year of employment. Vesting increases ratably to 100% after the sixth
year of employment. Pursuant to the profit sharing plan, the Company has
expensed approximately $243,000, $243,000 and $217,000 during the years ended
December 31, 1998, 1997 and 1996, respectively. Contributions to the profit
sharing plan are at the discretion of the Board of Directors.

NOTE 14. RELATED PARTY TRANSACTIONS:

Pursuant to agreements between PMC Capital and its wholly owned subsidiaries,
during the three years ended December 31, 1998, PMC provided certain services
to the subsidiaries at no cost. These services and costs include salaries, rent
and other general corporate expenses. However, PMC retains all cash premiums on
First Western's SBA Guaranteed Sales ($769,000, $1,991,000, and $1,937,000
during the years ended December 31, 1998, 1997 and 1996, respectively) as
compensation for these services and for working capital provided by PMC Capital
to First Western.

Pursuant to SBA rules and regulations, distributions of the net assets of the
Company's wholly-owned regulated investment company subsidiaries are limited.
As of December 31, 1998 and 1997, the amount of dividends available for
distribution were approximately $1.9 million and $0.7 million, respectively.
See the accompanying consolidating financial statements.

Pursuant to the investment management agreements entered into between PMC
Commercial and PMC Advisers, fees of between 0.875% and 1.67%, annually, are
charged by the Company based upon the average principal outstanding of the
Company's loans. In addition, during 1996 the investment management agreement
was amended to include compensation to PMC Advisers for its assistance in the
issuance of PMC Commercial's debt and equity securities. During 1998, a second
investment management agreement was entered into which provides a fee to be
paid to the PMC Advisers for providing services relating to the supervision of
leases entered into by PMC Commercial and charged a fee relating to the
acquisition by


                                     F-23
<PAGE>   51

                       PMC CAPITAL, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


NOTE 15. UNCONSOLIDATED WHOLLY OWNED ENTITIES:

PMC Commercial of limited service hospitality properties. Fees for the three
years in the period ended December 31, 1998 were as follows:

<TABLE>
<CAPTION>
                                                          Years Ended December 31,
                                                --------------------------------------------
         Type of Fee                                1998            1997           1996
         -----------                            ------------    ------------    ------------
                                                               (In thousands)

<S>                                             <C>             <C>             <C>         
Loan servicing and origination fee              $      1,789    $      1,662    $      1,310
Lease supervision                                        218
Issuance of equity capital                              --              --               251
Structured financing                                     167            --              --
Property acquisition                                     466            --              --
                                                ------------    ------------    ------------
                                                $      2,640    $      1,622    $      1,561
                                                ============    ============    ============
</TABLE>

As described in Note 1, the consolidated financial statements include the
accounts of PMC and its wholly owned regulated investment company subsidiaries.
The accounts of PMC Advisers, PMC Funding Corp., the 1996 Partnership and the
1998 Partnership(the "Unconsolidated Entities") are accounted for by the equity
method of accounting in conformity with Federal securities law.

PMC Advisers. PMC Capital allocates overhead to PMC Advisers to the extent that
PMC Advisers utilizes the staff and facilities of PMC Capital. The overhead
allocated during the years ended December 31, 1998, 1997 and 1996, was
$1,470,000, $1,603,000, and $1,571,000 respectively. These amounts are included
in Other income, net, on the accompanying consolidated statements of income. In
no event will the allocated expenses exceed the income available from the
operations of PMC Advisers.

PMC Funding Corp. PMC Funding Corporation is a corporation that holds assets on
behalf of the Company. PMC Funding Corp. owns a 99% limited partnership
interest in Asset Management Series A, L.L.C. The accounts of Asset Investments
Series A, L.L.C., have been consolidated with PMC Funding Corp.

PMC Capital Limited Partnership. On November 13, 1996, the 1996 Partnership (a
newly formed special purpose affiliate of the Company) completed a private
placement of approximately $40.7 million of its Loan-Backed Fixed Rate Notes,
Series 1996-A (the "1996 Notes"). The 1996 Notes, issued at par, which have a
stated maturity in 2011 and bear interest at the rate of 6.725% per annum, are
collateralized by loans contributed by PMC Capital to the 1996 Partnership. In
connection with this private placement, the 1996 Notes were given a rating of
"Aa2" by Moody's Investors Service. The terms of the 1996 Notes provide that
the partners of the 1996 Partnership are not liable for any payment on the 1996
Notes. Accordingly, the 1996 Partnership has the exclusive obligation for the
repayment of the 1996 Notes, and the holders of the 1996 Notes have no recourse
to PMC Capital or its other subsidiaries or their assets in the event of
nonpayment of the loans. The net proceeds from the issuance of the 1996 Notes
were distributed to PMC Capital. The net effect of the contributed loans less
the distributed funds comprises the limited partners capital on the condensed
combining balance sheet. PMC Capital either directly or indirectly owns 100% of
the 1996 Partnership.

PMC Capital L.P. 1998-1. On November 24, 1998, the 1998 Partnership (a newly
formed special purpose affiliate of the Company) completed a private placement
of approximately $39.6 million of its Loan-Backed Variable Rate Notes, Series
1998-1 (the "1998 Notes"). The 1998 Notes, issued at par, which have a stated
maturity in 2021 and bear interest at the prime rate as published in the Wall
Street Journal (adjusted quarterly) less 1%, are collateralized by loans
contributed by PMC Capital to the 1998 Partnership. In connection with this
private placement, the Notes were given a rating of "Aaa" by Moody's Investors
Service. The terms of the 1998 Notes provide that the partners of the 1998
Partnership are not liable for any payment on the 1998 Notes. Accordingly,
the 1998 Partnership has the exclusive obligation for the repayment of the 1998
Notes, and the holders of the 1998 Notes have no recourse to PMC Capital or its
other subsidiaries or their assets in the event of nonpayment of the loans. The
net proceeds from the issuance of the 1998 Notes were distributed to PMC
Capital. The net effect of the contributed loans less the distributed funds
comprises the partners capital on the following condensed combining balance
sheet. 


                                     F-24
<PAGE>   52
                       PMC CAPITAL, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

PMC Capital either directly or indirectly owns 100% of the 1998 Partnership.

NOTE 15. UNCONSOLIDATED WHOLLY OWNED ENTITIES: (CONTINUED)

The following are condensed combined financial statements of the Unconsolidated
Entities as of December 31, 1998 and 1997 and for the three years in the period
ended December 31, 1998:


                       CONDENSED COMBINED BALANCE SHEETS
                                 (In thousands)

<TABLE>
<CAPTION>
                                                                   DECEMBER 31,
                                                          ----------------------------
                                                              1998            1997       
                                                          ------------    ------------
<S>                                                       <C>             <C>
ASSETS
Investments at value:
Loans receivable, net .................................   $     61,768    $     33,975
Cash equivalents ......................................             64              37
Restricted investments and real property owned ........          9,096           2,686
                                                          ------------    ------------
                                                                70,928          36,698
Other assets ..........................................          1,673           1,762
                                                          ------------    ------------
Total assets ..........................................   $     72,601    $     38,460
                                                          ============    ============

LIABILITIES AND SHAREHOLDERS' EQUITY
LIABILITIES:
Notes payable .........................................   $     57,053    $     29,007
Other liabilities .....................................          2,618           1,656
                                                          ------------    ------------
                                                                59,671          30,663
                                                          ------------    ------------
OWNERS' EQUITY:
Common Stock and additional paid-in capital ...........            526             477
Partners' Capital .....................................         12,740           7,726
Retained deficit ......................................           (336)           (406)
                                                          ------------    ------------
                                                                12,930           7,797
                                                          ------------    ------------
Total liabilities and owners' equity ..................   $     72,601    $     38,460
                                                          ============    ============
</TABLE>

                    CONDENSED COMBINED STATEMENTS OF INCOME
              FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
                                 (In thousands)

<TABLE>
<CAPTION>
                                               1998           1997           1996    
                                           ------------   ------------   ------------
<S>                                        <C>            <C>            <C>         
INCOME:
Investment income ......................   $      4,536   $      5,021   $        714
Other income, net ......................          1,677          1,716            173
                                           ------------   ------------   ------------
Total income ...........................          6,213          6,737            887
                                           ------------   ------------   ------------
EXPENSES:
Interest ...............................          1,833          2,287            362
General and administrative expenses ....          1,756          1,890            156
                                           ------------   ------------   ------------
Total expense ..........................          3,589          4,177            518
                                           ------------   ------------   ------------
NET INCOME .............................   $      2,624   $      2,560   $        369
                                           ============   ============   ============
</TABLE>

NOTE 16. STOCK BASED COMPENSATION PLAN:

During fiscal year 1998 and 1997 the Company granted stock options under the
PMC Capital, Inc. 1997 Non-Employee Director Stock Option Plan and the PMC
Capital, Inc. 1997 Employee Stock Option Plan (collectively, the "Plan") it
sponsored. The Company applies the Accounting Principles Board Opinion No. 25
and related interpretations in accounting for the Plan. In 1995, SFAS No. 123
"Accounting for Stock-Based compensation" ("SFAS No. 123") was issued which, if
fully adopted by the Company, would change the methods the Company applies in
recognizing the cost of the Plan. Adoption of the cost recognition provisions
of SFAS No. 123 is optional and the Company has decided not to elect these
provisions of SFAS No. 123. However, pro-forma disclosures as if the Company
adopted the cost recognition provisions of SFAS No. 123 are required by SFAS
No. 123 and are presented below.

                                     F-25
<PAGE>   53
                       PMC CAPITAL, INC. AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


NOTE 16. STOCK BASED COMPENSATION PLAN: (CONTINUED)

Under the Plan, the Company is authorized to issue 6% of the then outstanding
shares of Common Stock pursuant to "Awards" granted as incentive stock options
(intended to qualify under Section 422 of the Internal Revenue Code of 1986, as
amended) to employees and non-qualified stock options to employees and
non-employee directors.

STOCK OPTIONS

The Company granted stock options during the years ended December 31, 1998 and
1997 to certain employees and directors. The stock options granted all have
contractual terms of five years. All of the options granted to the employees
and directors have an exercise price equal to the fair market value of the
stock at grant date. The range of options granted during the years ended
December 31, 1998 and 1997 was from $13.56 to $14.31. The options granted vest
100% on the first anniversary of the date of grant.

<TABLE>
<CAPTION>
                                                                       1998                          1997
                                                           --------------------------      ------------------------
                                                           NUMBER OF         WEIGHTED      NUMBER OF       WEIGHTED
                                                            SHARES            AVERAGE        SHARES        AVERAGE
                                                           UNDERLYING        EXERCISE      UNDERLYING      EXERCISE
                                                            OPTIONS           PRICES        OPTIONS         PRICES
                                                           ----------        --------      ----------      --------
        <S>                                                 <C>               <C>            <C>            <C>
        Outstanding January 1.......................         86,755           $ 14.21          --              n/a
        Granted.....................................         51,000           $ 14.07        86,755         $14.21
        Exercised...................................           --                 --           --              n/a
        Forfeited and expired.......................          2,900           $ 14.13          --              n/a
                                                            -------                          ------

        Outstanding December 31.....................        134,855           $ 14.18        86,755         $14.21
                                                            =======           =======        ======         ======

        Exercisable at December 31..................         86,455           $ 14.21          --              n/a
                                                            =======           =======        ======         ======

        Weighted-average fair value of
           options granted during the year..........                 $ 0.78                          $ 0.54
                                                                     ======                          ======
</TABLE>

The weighted-average remaining term of the options outstanding as of December
31, 1998 is 3.81 years. The fair value of each stock option granted is
estimated on the date of grant using the Black-Scholes option-pricing model
with the following weighted-average assumptions for grants during the years
ended December 31, 1998 and 1997:

<TABLE>
<CAPTION>
           ASSUMPTION                  1998       1997
           ----------                 ------     ------
           <S>                        <C>        <C>
           Expected Term (years)        3.0        3.0
           Risk-Free Interest Rate     5.55%      6.17%
           Expected Dividend Yield     8.80%      8.77%
           Expected Volatility        15.63%     11.41%
</TABLE>

                                     F-26
<PAGE>   54

PRO-FORMA NET INCOME AND EARNINGS PER COMMON SHARE

Had the compensation cost for the Company's stock-based compensation plans been
determined consistent with SFAS No. 123, the Company's net income and earnings
per common share for the years ended December 31, 1998 and 1997 would
approximate the pro forma amounts below (in thousands, except per share data):

<TABLE>
<CAPTION>
                                              DECEMBER 31, 1998            DECEMBER 31, 1997
                                         --------------------------     -------------------------
                                         AS REPORTED      PRO FORMA     AS REPORTED     PRO FORMA 
                                         -----------      ---------     -----------     ---------
        <S>                                <C>             <C>             <C>           <C>    
        SFAS No. 123 Charge                $  --           $    44         $  --         $    25
        APB 25 Charge                      $  --           $  --           $  --         $  --
        Net Income                         $13,949         $13,905         $15,622       $15,597
        Basic and Diluted
          Earnings Per Common Share        $  1.16         $  1.16         $  1.35       $  1.35
</TABLE>


The effects of applying SFAS No. 123 in this pro forma disclosure are not
indicative of future amounts.


                                     F-27
<PAGE>   55

                      REPORT OF INDEPENDENT ACCOUNTANTS ON
                       CONSOLIDATING FINANCIAL STATEMENTS


To the Board of Directors
PMC Capital, Inc.:

In our opinion, the accompanying consolidating balance sheet and related
consolidating statements of income, cash flows and shareholders' equity is
fairly stated, in all material respects, in relation to the consolidated
financial statements, taken as a whole, of PMC Capital, Inc. and subsidiaries
for the year ended December 31, 1998, which are covered by our report dated
March 4, 1999 presented on page F-4 of this Form 10-K. Our audit was conducted
for the purpose of forming an opinion on the consolidated financial statements
taken as a whole. This information is presented for purposes of additional
analysis and is not a required part of the consolidated financial statements.
Such information has been subjected to the auditing procedures applied in the
audit of the consolidated financial statements.

                                           PRICEWATERHOUSECOOPERS LLP


March 4, 1999
Dallas, Texas


                                     F-28

<PAGE>   56


                       PMC CAPITAL, INC. AND SUBSIDIARIES
                           CONSOLIDATING BALANCE SHEET
                                DECEMBER 31, 1998
                      (IN THOUSANDS, EXCEPT PER SHARE DATA)

<TABLE>
<CAPTION>
                                                                            CONSOLIDATED          
                                                                               BEFORE       PMC   
                                                                 ELIMINATION ELIMINATION  CAPITAL,
                                                    CONSOLIDATED   ENTRIES     ENTRIES      INC.  
                                                    ------------  ---------   ---------  ---------
<S>                                                   <C>         <C>         <C>        <C>        
                          ASSETS

INVESTMENTS AT VALUE, SEE ACCOMPANYING SCHEDULE:
  Loans receivable, net ............................  $ 116,711   $      --   $ 116,711  $  43,387  
  Cash equivalents .................................     18,489          --      18,489     10,430  
  Investment in unconsolidated subsidiaries ........     12,930     (23,291)     36,221     36,221  
  Interest-only strip receivables ..................      4,168          --       4,168      1,477  
  Restricted investments ...........................      2,525          --       2,525         --  
  Mortgage-backed security of affiliate ............      2,168          --       2,168      2,168  
  Real property owned ..............................        109          --         109         --  
                                                      ---------   ---------   ---------  ---------  

Total investments ..................................    157,100     (23,291)    180,391     93,683  
                                                      ---------   ---------   ---------  ---------  

OTHER ASSETS:
  Receivable for loans sold ........................        156          --         156         12  
  Due from unconsolidated subsidiaries .............      2,579     (15,178)     17,757     17,692  
  Servicing asset ..................................      1,330          --       1,330         --  
  Deferred charges, deposits and other assets ......      1,140          --       1,140        270  
  Accrued interest receivable ......................        581          --         581        202  
  Cash .............................................        235          --         235        109  
  Property and equipment, net ......................        228          --         228        228  
                                                      ---------   ---------   ---------  ---------  

Total other assets .................................      6,249     (15,178)     21,427     18,513  
                                                      ---------   ---------   ---------  ---------  

TOTAL ASSETS .......................................  $ 163,349   $ (38,469)  $ 201,818  $ 112,196  
                                                      =========   =========   =========  =========  



             LIABILITIES AND SHAREHOLDERS' EQUITY

LIABILITIES:
  SBA debentures payable ...........................  $  39,790   $      --   $  39,790  $      --  
  Notes payable ....................................     35,000          --      35,000     35,000  
  Accounts payable .................................      1,728          --       1,728         52  
  Dividends payable ................................      3,020          --       3,020      2,957  
  Borrower advances ................................      1,598          --       1,598        356  
  Accrued interest payable .........................      1,264          --       1,264        430  
  Due to unconsolidated subsidiaries ...............          1     (15,178)     15,179          2  
  Deferred fee revenue .............................        666          --         666        428  
  Other liabilities ................................      1,131          --       1,131        820  
                                                      ---------   ---------   ---------  ---------  

Total liabilities ..................................     84,198     (15,178)     99,376     40,045  
                                                      ---------   ---------   ---------  ---------  

Cumulative preferred stock of subsidiary ...........      7,000       3,000       4,000         --  
                                                      ---------   ---------   ---------  ---------  

SHAREHOLDERS' EQUITY:
  Cumulative preferred stock of subsidiary, 3% .....         --      (3,000)      3,000         --  
  Common stock .....................................        118         (22)        140        118  
  Additional paid-in capital .......................     71,312     (22,373)     93,685     71,312  
  Undistributed net operating income ...............      1,495      (1,896)      3,391        721  
  Net unrealized depreciation on investments .......       (774)         --        (774)        --  
                                                      ---------   ---------   ---------  ---------  

                                                         72,151     (27,291)     99,442     72,151  
  Less treasury stock ..............................         --       1,000      (1,000)        --  
                                                      ---------   ---------   ---------  ---------  

Total shareholders' equity .........................     72,151     (26,291)     98,442     72,151  
                                                      ---------   ---------   ---------  ---------  

TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY .........  $ 163,349   $ (38,469)  $ 201,818  $ 112,196  
                                                      =========   =========   =========  =========  

NET ASSET VALUE PER COMMON SHARE ...................  $    6.10
                                                      =========

<CAPTION>
                                                           FIRST         WESTERN                    
                                                       WESTERN SBLC,    FINANCIAL          PMC     
                                                         INC. AND        CAPITAL        INVESTMENT
                                                       SUBSIDIARIES    CORPORATION      CORPORATION
                                                       ------------    -----------      -----------   
<S>                                                    <C>              <C>               <C>         
                          ASSETS                                                                      
                                                                                                      
INVESTMENTS AT VALUE, SEE ACCOMPANYING SCHEDULE:                                                      
  Loans receivable, net ............................   $  8,923         $ 21,232          $ 43,169    
  Cash equivalents .................................      2,099            3,882             2,078    
  Investment in unconsolidated subsidiaries ........         --               --                --    
  Interest-only strip receivables ..................      2,691               --                --    
  Restricted investments ...........................      2,311               --               214    
  Mortgage-backed security of affiliate ............         --               --                --    
  Real property owned ..............................          9               55                45    
                                                       --------         --------          --------    
                                                                                                      
Total investments ..................................     16,033           25,169            45,506    
                                                       --------         --------          --------    
                                                                                                      
OTHER ASSETS:                                                                                         
  Receivable for loans sold ........................        144               --                --    
  Due from unconsolidated subsidiaries .............         --               --                65    
  Servicing asset ..................................      1,330               --                --    
  Deferred charges, deposits and other assets ......        328              170               372    
  Accrued interest receivable ......................         25              103               251    
  Cash .............................................         59               27                40    
  Property and equipment, net ......................          0               --                --    
                                                       --------         --------          --------    
                                                                                                      
Total other assets .................................      1,886              300               728    
                                                       --------         --------          --------    
                                                                                                      
TOTAL ASSETS .......................................   $ 17,919         $ 25,469          $ 46,234    
                                                       ========         ========          ========    
                                                                                                      
                                                                                                      
                                                                                                      
             LIABILITIES AND SHAREHOLDERS' EQUITY                                                     
                                                                                                      
LIABILITIES:                                                                                          
  SBA debentures payable ...........................   $     --         $ 15,790          $ 24,000    
  Notes payable ....................................         --               --                --    
  Accounts payable .................................      1,646               29                 1    
  Dividends payable ................................         --               --                63    
  Borrower advances ................................        389              358               495    
  Accrued interest payable .........................         20              416               398    
  Due to unconsolidated subsidiaries ...............     13,780              120             1,277    
  Deferred fee revenue .............................         18              113               107    
  Other liabilities ................................        279                9                23    
                                                       --------         --------          --------    
                                                                                                      
Total liabilities ..................................     16,132           16,835            26,364    
                                                       --------         --------          --------    
                                                                                                      
Cumulative preferred stock of subsidiary ...........         --               --             4,000    
                                                       --------         --------          --------    
                                                                                                      
SHAREHOLDERS' EQUITY:                                                                                 
  Cumulative preferred stock of subsidiary, 3% .....         --               --             3,000    
  Common stock .....................................         --               21                 1    
  Additional paid-in capital .......................      2,000            7,934            12,439    
  Undistributed net operating income ...............      1,043              697               930    
  Net unrealized depreciation on investments .......       (256)             (18)             (500)   
                                                       --------         --------          --------    
                                                                                                      
                                                          2,787            8,634            15,870    
  Less treasury stock ..............................     (1,000)              --                --    
                                                       --------         --------          --------    
                                                                                                      
Total shareholders' equity .........................      1,787            8,634            15,870    
                                                       --------         --------          --------    
                                                                                                      
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY .........   $ 17,919         $ 25,469          $ 46,234    
                                                       ========         ========          ========    
                                                                                                      
NET ASSET VALUE PER COMMON SHARE ...................                                                  
</TABLE>


                 THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF
                   THESE CONSOLIDATING FINANCIAL STATEMENTS.


                                      F-29

<PAGE>   57


                       PMC CAPITAL, INC. AND SUBSIDIARIES
                        CONSOLIDATING STATEMENT OF INCOME
                      FOR THE YEAR ENDED DECEMBER 31, 1998
                      (IN THOUSANDS, EXCEPT PER SHARE DATA)



<TABLE>
<CAPTION>
                                                                          CONSOLIDATED            FIRST        WESTERN
                                                                             BEFORE      PMC   WESTERN SBLC,  FINANCIAL      PMC
                                                             ELIMINATION  ELIMINATION  CAPITAL,  INC. AND      CAPITAL    INVESTMENT
                                               CONSOLIDATED    ENTRIES      ENTRIES      INC.  SUBSIDIARIES  CORPORATION CORPORATION
                                               ------------    -------      -------      ----  ------------  ----------- -----------
<S>                                               <C>         <C>          <C>         <C>        <C>        <C>         <C>     
INVESTMENT INCOME:
  Interest ....................................   $ 17,214    $     --      $ 17,214    $  5,567   $  2,354    $  3,236    $  6,057
  Premium income ..............................        776          --           776         769          7          --          --
  Other investment income, net ................        807          --           807         351         66         212         178
                                                  --------    --------      --------    --------   --------    --------    --------

Total investment income .......................     18,797          --        18,797       6,687      2,427       3,448       6,235

Other income, net .............................      2,893          --         2,893       2,425        194          99         175
Equity in income (loss) of subsidiaries .......      2,624      (9,399)       12,023      12,023         --          --          --
                                                  --------    --------      --------    --------   --------    --------    --------

Total income ..................................     24,314      (9,399)       33,713      21,135      2,621       3,547       6,410
                                                  --------    --------      --------    --------   --------    --------    --------

EXPENSES:
  Interest ....................................      5,467          --         5,467       2,774         10       1,400       1,283
  Salaries and related benefits ...............      3,965          --         3,965       3,965         --          --          --
  General and administrative ..................        821          --           821         644         64          46          67
  Profit sharing plan .........................        243          --           243         243         --          --          --
  Rent ........................................        244          --           244         244         --          --          --
  Legal and Accounting ........................        182          --           182         180          1           1          --
  Small Business Administration fees ..........        106          --           106          --          4          36          66
  Directors and shareholders expense ..........         63          --            63          61          2          --          --
                                                  --------    --------      --------    --------   --------    --------    --------

Total expense .................................     11,091          --        11,091       8,111         81       1,483       1,416
                                                  --------    --------      --------    --------   --------    --------    --------


Net operating income ..........................     13,223      (9,399)       22,622      13,024      2,540       2,064       4,994
                                                  --------    --------      --------    --------   --------    --------    --------

REALIZED AND UNREALIZED GAIN (LOSS)
  ON INVESTMENTS:
    Loans written-off .........................       (219)         --          (219)         --        (57)        (99)        (63)
    Sale of assets ............................        925          --           925         925         --          --          --
    Change in unrealized appreciation
      (depreciation) on investments ...........         20          --            20          --        216          91        (287)
                                                  --------    --------      --------    --------   --------    --------    --------

                                                       726          --           726         925        159          (8)       (350)
                                                  --------    --------      --------    --------   --------    --------    --------

NET OPERATING INCOME AND REALIZED AND 
  UNREALIZED GAIN (LOSS) ON INVESTMENTS .......   $ 13,949    $ (9,399)     $ 23,348    $ 13,949   $  2,699    $  2,056    $  4,644
                                                   ========    ========      ========    ========   ========    ========    ========

PREFERRED DIVIDEND ............................   $    250    $   (250)     $    500    $    250   $     --    $     --    $    250
                                                  ========    ========      ========    ========   ========    ========    ========

BASIC AND DILUTED EARNINGS PER COMMON SHARE ...   $   1.16
                                                  ========
</TABLE>

                 THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF
                   THESE CONSOLIDATING FINANCIAL STATEMENTS.



                                      F-30

<PAGE>   58





                       PMC CAPITAL, INC. AND SUBSIDIARIES
                 CONSOLIDATING STATEMENT OF SHAREHOLDERS' EQUITY
                                December 31, 1998
                                 (IN THOUSANDS)


<TABLE>
<CAPTION>
                                                                                 ADDITIONAL  UNDISTRIBUTED
                                                          PREFERRED    COMMON     PAID-IN    NET OPERATING
                                                          STOCK, 3%    STOCK      CAPITAL      INCOME   
                                                          ---------   --------    --------    -------- 
<S>                                                        <C>        <C>         <C>         <C>         
PMC CAPITAL, INC

        BALANCES, JANUARY 1, 1998 ......................   $     --   $    116    $ 68,555    $  1,495    

        Net income .....................................         --         --          --      13,949    
        Preferred dividend of consolidated subsidiary ..         --         --          --        (250)   
        Dividend reinvestment plan,  198,329 shares ....         --          2       2,757          --    
        Dividends on common stock ......................         --         --          --     (14,473)   
                                                           --------   --------    --------    --------    

        BALANCES, DECEMBER 31, 1998 ....................   $     --   $    118    $ 71,312    $    721    
                                                           ========   ========    ========    ========    

FIRST WESTERN SBLC, INC. AND SUBSIDIARY

        BALANCES, JANUARY 1, 1998 ......................   $     --   $     --    $  2,000    $    960    

        Net income .....................................         --         --          --       2,483    
        Dividends to parent company ....................         --         --          --      (2,400)   
                                                           --------   --------    --------    --------    

        BALANCES, DECEMBER 31, 1998 ....................   $     --   $     --    $  2,000    $  1,043    
                                                           ========   ========    ========    ========    

WESTERN FINANCIAL CAPITAL CORPORATION

        BALANCES, JANUARY 1, 1998 ......................   $     --   $     21    $  7,934    $    257    

        Net income .....................................         --         --          --       1,965    
        Dividends to parent company ....................         --         --          --      (1,525)   
                                                           --------   --------    --------    --------    

        BALANCES, DECEMBER 31, 1998 ....................   $     --   $     21    $  7,934    $    697    
                                                           ========   ========    ========    ========    

PMC INVESTMENT CORPORATION

        BALANCES, JANUARY 1, 1998 ......................   $  3,000   $      1    $ 12,439    $    275    

        Net income .....................................         --         --          --       4,931    
        Dividends to parent company ....................         --         --          --      (4,026)   
        Dividends, preferred ...........................         --         --          --        (250)   
                                                           --------   --------    --------    --------    

        BALANCES, DECEMBER 31, 1998 ....................   $  3,000   $      1    $ 12,439    $    930    
                                                           ========   ========    ========    ========    

ELIMINATION ADJUSTMENTS
        Equity in income of subsidiaries ...............         --         --          --      (9,399)   
        Dividends to parent ............................         --         --          --       7,951    
        Preferred dividend of consolidated subsidiary ..         --         --          --         250    
        Stock of subsidiaries ..........................     (3,000)       (22)    (22,373)         --    
        Undistributed earnings of subsidiaries .........         --         --          --        (698)   
                                                           --------   --------    --------    --------    

                                                             (3,000)       (22)    (22,373)     (1,896)   
                                                           --------   --------    --------    --------    


CONSOLIDATED ...........................................   $     --   $    118    $ 71,312    $  1,495    
                                                           ========   ========    ========    ========    

<CAPTION>
                                                            NET
                                                         UNREALIZED
                                                         APPRECIATION                        TOTAL
                                                        (DEPRECIATION)      TREASURY      SHAREHOLDERS'
                                                        ON INVESTMENTS        STOCK          EQUITY
                                                        --------------        -----          ------
<S>                                                      <C>               <C>             <C>      
PMC CAPITAL, INC
                                                                                                     
        BALANCES, JANUARY 1, 1998 ......................  $     --          $      --       $ 70,166 
                                                                                                     
        Net income .....................................        --                 --         13,949 
        Preferred dividend of consolidated subsidiary ..        --                 --           (250)
        Dividend reinvestment plan,  198,329 shares ....        --                 --          2,759 
        Dividends on common stock ......................        --                 --        (14,473)
                                                          --------          ---------       -------- 
                                                                                                     
        BALANCES, DECEMBER 31, 1998 ....................  $     --          $      --       $ 72,151 
                                                          ========          =========       ======== 
                                                                                                     
FIRST WESTERN SBLC, INC. AND SUBSIDIARY                                                              
                                                                                                     
        BALANCES, JANUARY 1, 1998 ......................  $   (472)         $  (1,000)      $  1,488 
                                                                                                     
        Net income .....................................       216                 --          2,699 
        Dividends to parent company ....................        --                 --         (2,400)
                                                          --------          ---------       -------- 
                                                                                                     
        BALANCES, DECEMBER 31, 1998 ....................  $   (256)         $  (1,000)      $  1,787 
                                                          ========          =========       ======== 
                                                                                                     
WESTERN FINANCIAL CAPITAL CORPORATION                                                                
                                                                                                     
        BALANCES, JANUARY 1, 1998 ......................  $   (109)         $      --       $  8,103 
                                                                                                     
        Net income .....................................        91                 --          2,056 
        Dividends to parent company ....................        --                 --         (1,525)
                                                          --------          ---------       -------- 
                                                                                                     
        BALANCES, DECEMBER 31, 1998 ....................  $    (18)         $      --       $  8,634 
                                                          ========          =========       ======== 
                                                                                                     
PMC INVESTMENT CORPORATION                                                                           
                                                                                                     
        BALANCES, JANUARY 1, 1998 ......................  $   (213)         $      --       $ 15,502 
                                                                                                     
        Net income .....................................      (287)                --          4,644 
        Dividends to parent company ....................        --                 --         (4,026)
        Dividends, preferred ...........................        --                 --           (250)
                                                          --------          ---------       -------- 
                                                                                                     
        BALANCES, DECEMBER 31, 1998 ....................  $   (500)         $      --       $ 15,870 
                                                          ========          =========       ======== 
                                                                                                     
ELIMINATION ADJUSTMENTS                                                                              
        Equity in income of subsidiaries ...............        --                 --         (9,399)
        Dividends to parent ............................        --                 --          7,951 
        Preferred dividend of consolidated subsidiary ..        --                 --            250 
        Stock of subsidiaries ..........................        --              1,000        (24,395)
        Undistributed earnings of subsidiaries .........        --                 --           (698)
                                                          --------          ---------       -------- 
                                                                                                     
                                                                --              1,000        (26,291)
                                                          --------          ---------       -------- 
                                                                                                     
                                                                                                     
CONSOLIDATED ...........................................  $   (774)         $      --       $ 72,151 
                                                          ========          =========       ======== 
</TABLE>


                 THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF
                    THESE CONSOLIDATING FINANCIAL STATEMENTS.


                                      F-31

<PAGE>   59


                       PMC CAPITAL, INC. AND SUBSIDIARIES
                     CONSOLIDATING STATEMENTS OF CASH FLOWS
                      FOR THE YEAR ENDED DECEMBER 31, 1998
                                 (IN THOUSANDS)

<TABLE>
<CAPTION>
                                                                                           CONSOLIDATED               
                                                                                              BEFORE                   
                                                                              ELIMINATION   ELIMINATION   PMC CAPITAL, 
                                                              CONSOLIDATED      ENTRIES       ENTRIES        INC.      
                                                              ------------    -----------   -----------   ------------      
<S>                                                            <C>           <C>           <C>           <C>         
CASH FLOWS FROM OPERATING ACTIVITIES:
  Net operating income and realized and
    unrealized gain (loss) on investments ..................     $ 13,949      $ (9,399)     $ 23,348      $ 13,949    
  Adjustments to reconcile net operating
    income and realized and unrealized gain
    (loss) on investments to net cash
    provided by operating activities:
        Loans funded, held for sale ........................       (7,407)           --        (7,407)           --    
        Proceeds from sale of guaranteed loans .............        9,978            --         9,978            --    
        Change in unrealized depreciation on
            investments and loans written-off ..............          199            --           199            --    
        Unrealized premium income, net .....................           (7)           --            (7)           --    
        Depreciation and amortization ......................        1,340            --         1,340           107    
        Accretion of loan discount and deferred fees .......       (1,163)           --        (1,163)         (277)   
        Deferred fees collected ............................           91            --            91            28    
        (Gain) loss on sale of assets ......................         (928)           --          (928)         (925)   
        Equity in income of subsidiaries, net ..............       (2,624)           --        (2,624)       (2,624)   
       Net change in operating assets and liabilities:
           Accrued interest receivable .....................           29            --            29            35    
           Other assets ....................................          338            --           338           106    
           Accrued interest payable ........................          (52)           --           (52)           (1)   
           Borrower advances ...............................          (81)           --           (81)          299    
           Other liabilities ...............................       (1,610)           --        (1,610)           66    
                                                                 --------      --------      --------      --------    
NET CASH PROVIDED BY OPERATING ACTIVITIES ..................       12,052        (9,399)       21,451        10,763    
                                                                 --------      --------      --------      --------    

CASH FLOWS FROM INVESTING ACTIVITIES:
  Loans funded .............................................      (59,043)           --       (59,043)      (29,723)   
  Principal collected and other adjustments ................       24,661            --        24,661        13,535    
  Proceeds from interest-only strip receivable .............          792            --           792            --    
  Proceeds from unconsolidated subsidiary ..................           -- 
  Purchase of furniture and fixtures and other
     assets ................................................         (146)           --          (146)         (144)   
  Purchase of mortgage-backed security of affiliate ........       (2,168)           --        (2,168)       (2,168)   
  Proceeds from sale of assets .............................          301            --           301       (22,289)   
  Proceeds from partnership distributions ..................        3,012         3,012            --            --    
  Release of (investment in) restricted cash ...............          273            --           273            --    
  Advances to (from) parent company ........................       (1,555)       (3,840)        2,285         2,285    
  Investment in unconsolidated subsidiary ..................       (3,253)        9,399       (12,652)      (12,652)   
                                                                 --------      --------      --------      --------    
NET CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES ........      (37,126)        8,571       (45,697)      (51,156)   
                                                                 --------      --------      --------      --------    

CASH FLOWS FROM FINANCING ACTIVITIES:
   Proceeds from issuance of common stock ..................        2,061            --         2,061         2,061    
   Proceeds from unconsolidated subsidiary .................       40,876            --        40,876        40,876    
   Payment of dividends to parent ..........................           --        (3,012)        3,012        10,962    
   Payment of dividends on common stock ....................      (14,771)           --       (14,771)      (14,771)   
   Payment of dividends on preferred stock .................         (250)           --          (250)           --    
   Payment of SBA debentures ...............................       (1,500)           --        (1,500)           --    
   Advances to (from) parent company........................           --         3,840        (3,840)           --
   Payment of issuance costs on notes and debentures .......         (119)           --          (119)           (4)   
                                                                 --------      --------      --------      --------    
                                                                                                                   
NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES ........       26,297           828        25,469        39,124    
                                                                 --------      --------      --------      --------    

NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS .......        1,223            --         1,223        (1,269)   

CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR ...............       17,502            --        17,502        11,808    
                                                                 --------      --------      --------      --------    

CASH AND CASH EQUIVALENTS, END OF YEAR .....................     $ 18,725      $     --      $ 18,725      $ 10,539    
                                                                 ========      ========      ========      ========    

SUPPLEMENTAL DISCLOSURE:
   Interest paid ...........................................     $  5,474      $     --      $  5,474      $  2,731    
                                                                 ========      ========      ========      ========    

   Dividends reinvested ....................................     $    700      $     --      $    700      $    700    
                                                                 ========      ========      ========      ========    

   Reclassification from loans receivable
     to real property owned ................................     $    109      $     --      $    109      $     --    
                                                                 ========      ========      ========      ========    

   Loans contributed to unconsolidated subsidiary, net .....     $ 43,144      $     --      $ 43,144      $ 43,144    
                                                                 ========      ========      ========      ========    

<CAPTION>
                                                                 FIRST        WESTERN
                                                              WESTERN SBLC,   FINANCIAL        PMC
                                                                INC., AND      CAPITAL      INVESTMENT
                                                               SUBSIDIARY    CORPORATION   CORPORATION
                                                                --------      --------      --------
<S>                                                            <C>           <C>           <C>     
CASH FLOWS FROM OPERATING ACTIVITIES:
  Net operating income and realized and
    unrealized gain (loss) on investments ..................    $  2,699      $  2,056      $  4,644
  Adjustments to reconcile net operating
    income and realized and unrealized gain
    (loss) on investments to net cash
    provided by operating activities:
        Loans funded, held for sale ........................      (7,407)           --            --
        Proceeds from sale of guaranteed loans .............       9,978            --            --
        Change in unrealized depreciation on
            investments and loans written-off ..............        (159)            8           350
        Unrealized premium income, net .....................          (7)           --            --
        Depreciation and amortization ......................       1,091            58            84
        Accretion of loan discount and deferred fees .......        (255)         (200)         (431)
        Deferred fees collected ............................          23            16            24
        (Gain) loss on sale of assets ......................          (8)           (7)           12
        Equity in income of subsidiaries, net ..............          --            --            --
       Net change in operating assets and liabilities:
           Accrued interest receivable .....................         (13)           21           (14)
           Other assets ....................................         155            37            40
           Accrued interest payable ........................          (5)          (50)            4
           Borrower advances ...............................         (75)          146          (451)
           Other liabilities ...............................      (1,437)         (208)          (31)
                                                                --------      --------      --------
NET CASH PROVIDED BY OPERATING ACTIVITIES ..................       4,580         1,877         4,231
                                                                --------      --------      --------

CASH FLOWS FROM INVESTING ACTIVITIES:
  Loans funded .............................................      (3,174)      (12,027)      (14,119)
  Principal collected and other adjustments ................         816         4,954         5,356
  Proceeds from interest-only strip receivable .............         792            --            --
  Proceeds from unconsolidated subsidiary .................. 
  Purchase of furniture and fixtures and other
     assets ................................................          --            --            (2)
  Purchase of mortgage-backed security of affiliate ........          --            --            --
  Proceeds from sale of assets .............................         104         7,961        14,525
  Proceeds from partnership distributions ..................          --            --            -- 
  Release of (investment in) restricted cash ...............         283            --           (10)
  Advances to (from) parent company ........................          --            --            -- 
  Investment in unconsolidated subsidiary ..................          --            --            -- 
                                                                --------      --------      --------
NET CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES ........      (1,179)          888         5,750
                                                                --------      --------      --------

CASH FLOWS FROM FINANCING ACTIVITIES:
   Proceeds from issuance of common stock ..................          --            --            -- 
   Proceeds from unconsolidated subsidiary .................          --            --            -- 
   Payment of dividends to parent ..........................      (2,400)       (1,525)       (4,025)
   Payment of dividends on common stock ....................          --            --            --
   Payment of dividends on preferred stock .................          --            --          (250)
   Payment of SBA debentures ...............................          --        (1,500)           --
   Advances to (from) parent company........................          62           124        (4,026)
   Payment of issuance costs on notes and debentures .......          --           (65)          (50)
                                                                --------      --------      --------
NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES ........      (2,338)       (2,966)       (8,351)
                                                                --------      --------      --------

NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS .......       1,063          (201)        1,630

CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR ...............       1,095         4,110           489
                                                                --------      --------      --------

CASH AND CASH EQUIVALENTS, END OF YEAR .....................    $  2,158      $  3,909      $  2,119
                                                                ========      ========      ========

SUPPLEMENTAL DISCLOSURE:
   Interest paid ...........................................    $     14      $  1,451      $  1,278
                                                                ========      ========      ========

   Dividends reinvested ....................................    $     --      $     --      $     --
                                                                ========      ========      ========

   Reclassification from loans receivable
     to real property owned ................................    $      9      $     55      $     45
                                                                ========      ========      ========

   Loans contributed to unconsolidated subsidiary, net .....    $     --      $     --      $     --
                                                                ========      ========      ========
</TABLE>


                 THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF
                    THESE CONSOLIDATED FINANCIAL STATEMENTS.



                                      F-32
<PAGE>   60

                       REPORT OF INDEPENDENT ACCOUNTANTS


To the General Partner
PMC Capital Limited Partnership:

In our opinion, the accompanying statements of assets, liabilities and
partners' capital and the related statements of income, partners' capital and
cash flows present fairly, in all material respects, the financial position of
PMC Capital Limited Partnership at December 31, 1998 and 1997 and the results
of its operations and cash flows for each of the two years in the period ended
December 31, 1998 and for the period from November 8, 1996 (inception) to
December 31, 1996, in conformity with generally accepted accounting principles.
These financial statements are the responsibility of the Company's management;
our responsibility is to express an opinion on these financial statements based
on our audits. We conducted our audits of these statements in accordance with
generally accepted auditing standards which require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test
basis, evidence supporting the amounts and disclosures in the financial
statements, assessing the accounting principles used and significant estimates
made by management, and evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for the
opinion expressed above.

                                          PRICEWATERHOUSECOOPERS LLP

March 4, 1999
Dallas, Texas


                                     F-33


<PAGE>   61
                        PMC CAPITAL LIMITED PARTNERSHIP
            STATEMENT OF ASSETS, LIABILITIES AND PARTNERS' CAPITAL
                                 (In thousands)

<TABLE>
<CAPTION>
                                                                            December 31,
                                                                    ----------------------------
                                                                        1998            1997
                                                                    ------------    ------------
<S>                                                                 <C>             <C>         
                        ASSETS

Investments at value:
  Loans receivable, net .........................................   $     20,513    $     33,975
  Restricted investments - money market funds and cash ..........          2,408           2,219
                                                                    ------------    ------------
                                                                          22,921          36,194
                                                                    ------------    ------------
Other assets:
  Due from affiliates ...........................................              5              15
  Deferred borrowing costs ......................................            162             296
  Accrued interest receivable ...................................            104             189
                                                                    ------------    ------------
Total other assets ..............................................            271             500
                                                                    ------------    ------------
Total assets ....................................................   $     23,192    $     36,694
                                                                    ============    ============

           LIABILITIES AND PARTNERS' CAPITAL
Liabilities:
  Notes payable .................................................   $     16,070    $     28,866
  Accrued interest payable ......................................             91             164
  Other liabilities .............................................            190             141
  Due to affiliates .............................................           --                46
                                                                    ------------    ------------
Total liabilities ...............................................         16,351          29,217
                                                                    ------------    ------------
Commitments and contingencies

Partners' capital:
  General Partner's interest ....................................             (2)              4
  Limited Partner's interest ....................................          6,843           7,473
                                                                    ------------    ------------
                                                                           6,841           7,477
                                                                    ------------    ------------
Total liabilities and partners' capital .........................   $     23,192    $     36,694
                                                                    ============    ============
</TABLE>

The accompanying notes are an integral part of these financial statements.


                                     F-34

<PAGE>   62


                        PMC CAPITAL LIMITED PARTNERSHIP
                              STATEMENTS OF INCOME
                                (IN THOUSANDS)


<TABLE>
<CAPTION>
                                                                                November 8,
                                                  Years Ended December 31,    1996 (Inception)
                                                ---------------------------    to December 31,
                                                    1998            1997           1996
                                                ------------    ------------    ------------
<S>                                             <C>             <C>             <C>         
Investment income:
Interest ....................................   $      3,443    $      4,823    $        599
Other investment income, net ................            619             197             111
                                                ------------    ------------    ------------
Total investment income .....................          4,062           5,020             710
                                                ------------    ------------    ------------
Expenses:
Interest ....................................          1,537           2,287             362
General and administrative ..................            148             125              20
                                                ------------    ------------    ------------
Total expenses ..............................          1,685           2,412             382
                                                ------------    ------------    ------------
Net income ..................................   $      2,377    $      2,608    $        328
                                                ============    ============    ============
</TABLE>

  The accompanying notes are an integral part of these financial statements.


                                     F-35
<PAGE>   63

                        PMC CAPITAL LIMITED PARTNERSHIP
                        STATEMENTS OF PARTNERS' CAPITAL
         PERIOD FROM NOVEMBER 8, 1996 (INCEPTION) TO DECEMBER 31, 1998
                                 (In thousands)

<TABLE>
<CAPTION>
                                                             Limited        General
                                                            Partner's      Partner's
                                                            Interest        Interest         Total
                                                          ------------    ------------    ------------
<S>                                                       <C>             <C>             <C>       
Balance, November 8, 1996 (inception) .................   $       --      $       --      $       --

Limited Partner's contribution of loans receivable
and other assets ......................................         45,681            --            45,681

General Partner's cash contribution ...................           --                10              10

Net income ............................................            325               3             328

Partnership distributions .............................        (37,801)             (2)        (37,803)
                                                          ------------    ------------    ------------
Balance, December 31, 1996 ............................          8,205              11           8,216

Net income ............................................          2,582              26           2,608

Partnership distributions .............................         (3,314)            (33)         (3,347)
                                                          ------------    ------------    ------------
Balance, December 31, 1997 ............................          7,473               4           7,477

Net income ............................................          2,353              24           2,377

Partnership distributions .............................         (2,983)            (30)         (3,013)
                                                          ------------    ------------    ------------
Balance, December 31, 1998 ............................   $      6,843    $         (2)   $      6,841
                                                          ============    ============    ============
</TABLE>


  The accompanying notes are an integral part of these financial statements.


                                     F-36

<PAGE>   64

                        PMC CAPITAL LIMITED PARTNERSHIP
                            STATEMENTS OF CASH FLOWS
                                 (In thousands)


<TABLE>
<CAPTION>
                                                                                                           NOVEMBER 8,
                                                                       YEARS ENDED DECEMBER 31,          1996 (INCEPTION)
                                                                      --------------------------         TO DECEMBER 31,
                                                                        1998             1997                 1996
                                                                      --------          --------         ---------------
<S>                                                                   <C>               <C>               <C>         
CASH FLOWS FROM OPERATING ACTIVITIES:
  Net income                                                          $  2,377          $  2,608          $         328
  Adjustments to reconcile net income
    to net cash provided by operating activities:
        Amortization                                                       134                99                     16
        Accretion of loan discount and deferred fees                      (225)             (207)                   (28)
        Net change in operating assets and liabilities:
            Accrued interest receivable                                     85                50                   (239)
            Other assets and liabilities                                    49               152                    (11)
            Accrued interest payable                                       (73)              (69)                   233
                                                                      --------          --------                -------
NET CASH PROVIDED BY OPERATING ACTIVITIES                                2,347             2,633                    299
                                                                      --------          --------                -------
CASH FLOWS FROM INVESTING ACTIVITIES:
  Principal collected and other adjustments                             13,687             8,037                  3,904
  Release of (investment in) restricted cash                              (189)            3,225                 (5,444)
                                                                      --------          --------                -------
Net cash provided by (used in) investing activities                     13,498            11,262                 (1,540)
                                                                      --------          --------                -------
CASH FLOWS FROM FINANCING ACTIVITIES:
   Proceeds from issuance of notes payable                                --                --                   40,183
   Proceeds from issuance of general partnership interest                 --                --                       10
   Partner distributions                                                (3,013)           (3,347)               (37,803)
   Payment on notes payable                                            (12,796)          (11,317)                  --
   Advances from (to) affiliates, net                                      (36)              774                   (743)
   Payment of issuance costs on notes                                     --                  (5)                  (406)
                                                                      --------          --------                -------
NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES                    (15,845)          (13,895)                 1,241
                                                                      --------          --------                -------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS                      --                --                     --

CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR                              --                --                     --
                                                                      --------          --------                -------
CASH AND CASH EQUIVALENTS, END OF YEAR                                $   --            $   --                     --
                                                                      ========          ========                =======
Supplemental disclosure:
   
   Loans contributed from limited partner                             $   --            $   --                  $45,145
                                                                      ========          ========                =======
</TABLE>


 The accompanying notes are an integral part of these financial statements.


                                     F-37
<PAGE>   65

                        PMC CAPITAL LIMITED PARTNERSHIP
                         NOTES TO FINANCIAL STATEMENTS


NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:

         BUSINESS:

         PMC Capital Limited Partnership ("the Partnership") was formed as a
         Delaware limited partnership in November 1996 to act as a special
         purpose affiliate of PMC Capital, Inc. ("PMC Capital"), the 99%
         limited partner. PMC Capital is a diversified, closed-end management
         investment company that has elected to operate as a business
         development company under the Investment Company Act of 1940. PMC
         engages in the business of originating loans to small businesses
         either directly or through its three principal subsidiaries. The
         Partnership was established to acquire loans from PMC Capital and to
         issue fixed-rate debt through a private placement. PMC Capital is
         either directly or indirectly the sole partner of the Partnership.

         PMC Capital Corp. is a Delaware corporation formed in November 1996 to
         be the independent trustee of the general partner of the Partnership.
         PMC Trust 1996-A is a Delaware business trust formed in November 1996
         to be the general partner (1% ownership) of the Partnership.

         USE OF ESTIMATES IN THE PREPARATION OF FINANCIAL STATEMENTS

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

         VALUATION OF INVESTMENTS

         Loans receivable are carried at amortized cost which is the loan
         principal balance less deferred fees and discounts, unless there is
         doubt as to the realization of the loan (a "Problem Loan"). A
         valuation reserve is established for a Problem Loan based on the
         creditor's payment history, collateral value, guarantor support and
         other factors.

         Loans, including impaired loans, are generally classified as
         non-accrual if they are past due as to maturity or payment of
         principal or interest for a period of more than 60 days. If a loan or
         a portion of a loan is classified as doubtful or is partially reserved
         or charged-off, the loan is classified as non-accrual. Loans that are
         on a current payment status or past due less than 60 days may also be
         classified as non-accrual if repayment in full of principal and/or
         interest is in doubt.

         Deferred fees consist of non-refundable fees less direct loan
         origination costs. These fees are being recognized over the expected
         life of the related loan as an adjustment of yield.

         REALIZED GAIN (LOSS) ON INVESTMENTS

         Realized gains or losses are measured by the difference between the
         proceeds from the sale and the cost basis of the investment, without
         regard to unrealized gains and losses previously recognized. The gain
         or loss calculated also includes loans written-off or charged-down
         during the year and recoveries of loans written-off or charged-down in
         prior years.

         INTEREST INCOME

         Interest income on loans is accrued as earned. The accrual of interest
         is generally suspended when the related loan becomes 60 days past due
         ("Non-accrual Loan"). Interest income on a Non-accrual Loan is
         recognized on the cash basis.


                                     F-38
<PAGE>   66

                        PMC CAPITAL LIMITED PARTNERSHIP
                         NOTES TO FINANCIAL STATEMENTS

NOTE 1.  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: (CONTINUED)

         DEFERRED BORROWING COSTS

         Costs incurred in connection with the issuance of notes payable are
         included in deferred borrowing costs. These costs are amortized over
         the estimated life of the related obligation.

         STATEMENT OF CASH FLOWS

         The Company considers all highly liquid investments purchased with an
         original maturity of three months or less to be cash equivalents for
         purposes of the statement of cash flows.

         RECLASSIFICATION

         Certain prior period amounts have been reclassified to conform to
         current year presentation.

NOTE 2.  LOANS RECEIVABLE:

         On November 13, 1996, PMC Capital contributed approximately $45.7
         million of loans (the "Contributed Loans") to the Partnership without
         recourse to PMC Capital.

         At December 31, 1998 and 1997 their was no recorded investment in
         loans identified as impaired.

         The Company's portfolio of investments consists of loans to borrowers
         located principally in the southern portion of the United States. The
         most significant concentration of loans were as noted below:

<TABLE>
<CAPTION>
                                                 Percentage of Loan Portfolio
               State                                     December 31,
               -----                             ----------------------------              
                                                      1998          1997 
                                                     ------        ------ 
               <S>                               <C>               <C>

               Texas                                   39%           37%
               Arizona                                 11%            7%
               Virginia                                 8%            5%
               Tennessee                                8%            5%
               Florida                                  5%            9%
               Other                                   29%           37%
                                                      ---           ---
                                                      100%          100% 
                                                      ===           ===  
</TABLE>

         There were no loans receivable; (i) greater than 60 days past due,
         (ii) on which litigation against the borrowers had commenced, or (iii)
         which were in the process of liquidation at December 31, 1998 and
         1997.


NOTE 3.  CREDIT RISK:

         At December 31, 1998 and 1997 loans to businesses in the lodging
         industry comprised 96% and 93% of loans receivable and 85% and 88% of
         total assets, respectively. There can be no assurance that the
         Partnership will experience the positive results which PMC Capital has
         historically achieved from these lending activities. Any economic
         factors that negatively impact the lodging industry could have a
         material adverse effect on the business of the Partnership.
         Additionally, at December 31, 1998 loans to businesses located in
         Texas and Arizona comprised approximately 39% and 11%, respectively,
         of the Partnership's outstanding loan portfolio. No other state had a
         concentration greater than 10%. A decline in economic conditions in
         any of these states may adversely affect the Partnership.


                                     F-39
<PAGE>   67

                        PMC CAPITAL LIMITED PARTNERSHIP
                         NOTES TO FINANCIAL STATEMENTS

NOTE 4.  NOTES PAYABLE:

         On November 13, 1996, the Partnership completed a private placement of
         approximately $40.7 million of its Loan-Backed Fixed Rate Notes,
         Series 1996-A (the "Notes"). The Notes, issued at par, which have a
         stated maturity in 2005 and bear interest at the rate of 6.725% per
         annum, are collateralized by the loans contributed by PMC Capital to
         the Partnership. In connection with this private placement, the Notes
         were given a rating of "Aa2" by Moody's Investors Service. The
         Partnership has the exclusive obligation for the repayment of the
         Notes, and the holders of the Notes have no recourse to PMC Capital or
         its other subsidiaries or their assets in the event of nonpayment of
         the loans. Required principal payments to the noteholders are based
         upon the collection of principal on the Contributed Loans. All
         principal collected on the Contributed Loans during the monthly period
         (as defined in the Trust Indenture) are used to make the required
         principal payment on the first business day of the following month. As
         of December 31, 1998 and 1997, the balance outstanding on the notes
         payable were $16,070,000 and $28,866,000, respectively.

NOTE 5.  PARTNERS' CAPITAL:

         The net proceeds from the issuance of the Notes (approximately $37.5
         million before giving effect to payment of offering costs of
         approximately $396,000 and after giving effect to the funding of a
         $2.04 million reserve fund held by the trustee as collateral) were
         distributed to PMC Capital. Pursuant to an agreement between PMC
         Capital and PMC Trust 1996-A, PMC Trust 1996-A waived any rights it
         had under the partnership agreement to receive any portion of such
         distribution.

NOTE 6.  FAIR VALUES OF FINANCIAL INSTRUMENTS:

         The estimates of fair value as required by Statement of Financial
         Accounting Standards ("SFAS") No. 107 differ from the value of the
         financial assets and liabilities determined by the General Partner
         primarily as a result of the effects of discounting future cash flows.
         Considerable judgement is required to interpret market data and
         develop the estimates of fair value. Accordingly, the estimates
         presented herein are not necessarily indicative of the amounts the
         Partnership could realize in a current market exchange or the amount
         that ultimately will be realized by the Partnership upon maturity or
         disposition.

         The estimated fair values of the Partnership's financial instruments
         pursuant to SFAS No. 107 are as follows:

<TABLE>
<CAPTION>
                                                     1998                        1997
                                           ------------------------    ------------------------
                                                         Estimated                   Estimated
                                            Carrying       Fair        Carrying        Fair
                                             Amount        Value        Amount         Value  
                                           ----------    ----------    ----------    ----------
                                                               (in thousands)
<S>                                        <C>           <C>           <C>           <C>       
Assets:
Loans receivable, net                      $   20,513    $   20,908    $   33,975    $   34,749
Restricted investments                          2,408         2,408         2,219         2,219

Liabilities:
Notes payable                                  16,070        16,192        28,866        29,075
</TABLE>

         Loans receivable, net: The estimated fair value for all fixed rate
         loans is estimated by discounting the estimated cash flows using the
         current rate at which similar loans would be made to borrowers with
         similar credit ratings and maturities. The impact of delinquent loans
         on the estimation of the fair values described above is not considered
         to have a material effect and accordingly, delinquent loans have been
         disregarded in the valuation methodologies employed.


                                     F-40
<PAGE>   68

                        PMC CAPITAL LIMITED PARTNERSHIP
                         NOTES TO FINANCIAL STATEMENTS

NOTE 6.  FAIR VALUES OF FINANCIAL INSTRUMENTS: (CONTINUED)

         Restricted investments : The carrying amount is a reasonable
         estimation of fair value.

         Notes payable: The estimated fair value is based on present value
         calculation using prices of the same or similar instruments after
         considering risk, current interest rates and remaining maturities.

NOTE 7.  RELATED PARTY TRANSACTIONS:

         At December 31, 1998 and 1997, the balance in due from affiliates of
         $5,000 and $15,000, respectively, were the result of payments on the
         Partnership's loans receivable deposited directly by borrowers into an
         affiliate's operating bank account. These balances were transferred to
         the appropriate company subsequent to the respective year end.



                                     F-41
<PAGE>   69
                       REPORT OF INDEPENDENT ACCOUNTANTS




To the General Partner
PMC Capital, L.P. 1998-1:

In our opinion, the accompanying statement of assets, liabilities and partners'
capital and the related statements of income, partners' capital and cash flows
present fairly, in all material respects, the financial position of PMC Capital,
L.P. 1998-1 at December 31, 1998 and the results of its operations and cash
flows for the period from October 23, 1998 (inception) to December 31, 1998, in
conformity with generally accepted accounting principles. These financial
statements are the responsibility of the Company's management; our
responsibility is to express an opinion on these financial statements based on
our audit. We conducted our audit of these statements in accordance with
generally accepted auditing standards which require that we plan and perform the
audit to obtain reasonable assurance about whether the financial statements are
free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements,
assessing the accounting principles used and significant estimates made by
management, and evaluating the overall financial statement presentation. We
believe that our audit provides a reasonable basis for the opinion expressed
above.


                                       PRICEWATERHOUSECOOPERS LLP

March 4, 1999
Dallas, Texas


                                      F-42

<PAGE>   70
                            PMC CAPITAL, L.P. 1998-1
             STATEMENT OF ASSETS, LIABILITIES AND PARTNERS' CAPITAL
                                 (IN THOUSANDS)

                                                                December 31,
                                                                    1998
                                                                ------------
<TABLE>
<S>                                                              <C>    
                                    ASSETS
Investments at value:
  Loans receivable, net ....................................     $41,255
  Restricted investments - money market funds and cash .....       5,898
                                                                 -------
                                                                  47,153
                                                                 -------
Other assets:
  Accrued interest receivable ..............................         168
                                                                 -------
Total other assets .........................................         168
                                                                 -------
Total assets ...............................................     $47,321
                                                                 =======
                       LIABILITIES AND PARTNERS' CAPITAL
Liabilities:
  Notes payable ............................................     $40,983
  Accrued interest payable .................................         239
  Due to affiliates ........................................         450
                                                                 -------
Total liabilities ..........................................      41,672
                                                                 -------
Commitments and contingencies

Partners' capital:
  General Partner's interest ...............................          --
  Limited Partner's interest ...............................       5,649
                                                                 -------
                                                                   5,649
                                                                 -------
Total liabilities and partners' capital ....................     $47,321
                                                                 =======
</TABLE>

   The accompanying notes are an integral part of these financial statements.


                                     F-43
<PAGE>   71

                            PMC CAPITAL, L.P. 1998-1
                              STATEMENT OF INCOME
                                 (IN THOUSANDS)

<TABLE>
<CAPTION>
                                              October 23,
                                            1998 (Inception)
                                            to December 31,
                                                1998
                                            ----------------
<S>                                         <C>
Investment income:
  Interest ................................     $421
  Other investment income, net ............       53
                                                ----
Total investment income ...................      474
                                                ----
Expenses:
  Interest ................................      296
                                                ----
Total expenses ............................      296
                                                ----
Net  income ...............................     $178
                                                ====
</TABLE>

  The accompanying notes are an integral part of these financial statements.


                                     F-44
<PAGE>   72

                            PMC CAPITAL, L.P. 1998-1
                         STATEMENT OF PARTNERS' CAPITAL
         PERIOD FROM OCTOBER 23, 1998 (INCEPTION) TO DECEMBER 31, 1998
                                 (IN THOUSANDS)

<TABLE>
<CAPTION>
                                                            Limited       General
                                                            Partner's     Partner's
                                                            Interest      Interest       Total
                                                            ---------     ---------    --------
<S>                                                         <C>           <C>          <C>     
Balance, October 23, 1998 (inception) .................     $     --      $     --     $     --

Limited Partner's contribution of loans receivable
     and other assets, net ............................       46,347            --       46,347

Partnership distributions .............................      (40,876)           --      (40,876)

Net income ............................................          178            --          178
                                                            --------      --------     --------
Balance, December 31, 1998 ............................     $  5,649      $     --     $  5,649
                                                            ========      ========     ========
</TABLE>

  The accompanying notes are an integral part of these financial statements.


                                     F-45
<PAGE>   73

                           PMC CAPITAL, L.P. 1998-1
                            STATEMENT OF CASH FLOWS
                                (IN THOUSANDS)


<TABLE>
<CAPTION>
                                                             October 23,
                                                          1998 (Inception)
                                                           to December 31,
                                                               1998
                                                          ----------------
<S>                                                       <C>
Cash flows from operating activities:
  Net income ..........................................     $    178
  Adjustments to reconcile net income
    to net cash provided by operating activities:
        Net change in operating assets and liabilities:
            Accrued interest receivable ...............         (168)
            Accrued interest payable ..................          239
                                                            --------
Net cash provided by operating activities .............          249
                                                            --------
Cash flows from investing activities:
  Principal collected and other adjustments ...........        1,889
  Investment in restricted cash .......................       (5,898)
                                                            --------
Net cash used in investing activities .................       (4,009)
                                                            --------
Cash flows from financing activities:
   Proceeds from issuance of notes payable ............       41,861
   Payment on notes payable ...........................         (878)
   Partner distributions ..............................      (40,876)
   Partner contributions ..............................        3,203
   Advances from affiliates, net ......................          450
                                                            --------
Net cash provided by  financing activities ............        3,760
                                                            --------
Net increase (decrease) in cash and cash equivalents ..           --

Cash and cash equivalents, beginning of period ........           --
                                                            --------
Cash and cash equivalents, end of year ................     $     --
                                                            ========
Supplemental disclosure:

   Loans contributed from limited partner .............     $ 43,144
                                                            ========
</TABLE>

   The accompanying notes are an integral part of these financial statements.


                                     F-46
<PAGE>   74

                            PMC CAPITAL L.P. 1998-1
                         NOTES TO FINANCIAL STATEMENTS

NOTE 1.  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:

         BUSINESS:

         PMC Capital L.P. 1998-1 ("the Partnership") was formed as a Delaware
         limited partnership in October 1998 to act as a special purpose
         affiliate of PMC Capital, Inc. ("PMC Capital"), the 99.9% limited
         partner. PMC Capital is a diversified, closed-end management
         investment company that has elected to operate as a business
         development company under the Investment Company Act of 1940. PMC
         engages in the business of originating loans to small businesses
         either directly or through its three principal subsidiaries. The
         Partnership was established to acquire loans from PMC Capital and to
         issue variable-rate debt through a private placement. PMC Capital is
         either directly or indirectly the sole partner of the Partnership.

         PMC Capital Corp. 1998-1 is a Delaware corporation formed in October
         1998 to be the General Partner (0.1% ownership) of the Partnership.

         USE OF ESTIMATES IN THE PREPARATION OF FINANCIAL STATEMENTS

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

         VALUATION OF INVESTMENTS

         Loans receivable are carried at amortized cost which is the loan
         principal balance, unless there is doubt as to the realization of the
         loan (a "Problem Loan"). A valuation reserve is established for a
         Problem Loan based on the creditor's payment history, collateral
         value, guarantor support and other factors.

         Loans, including impaired loans, are generally classified as
         non-accrual if they are past due as to maturity or payment of
         principal or interest for a period of more than 60 days. If a loan or
         a portion of a loan is classified as doubtful or is partially reserved
         or charged-off, the loan is classified as non-accrual. Loans that are
         on a current payment status or past due less than 60 days may also be
         classified as non-accrual if repayment in full of principal and/or
         interest is in doubt.

         REALIZED GAIN (LOSS) ON INVESTMENTS

         Realized gains or losses are measured by the difference between the
         proceeds from the sale and the cost basis of the investment, without
         regard to unrealized gains and losses previously recognized. The gain
         or loss calculated also includes loans written-off or charged-down
         during the year and recoveries of loans written-off or charged-down in
         prior years.

         INTEREST INCOME

         Interest income on loans is accrued as earned. The accrual of interest
         is generally suspended when the related loan becomes 60 days past due
         ("Non-accrual Loan"). Interest income on a Non-accrual Loan is
         recognized on the cash basis.


                                     F-47
<PAGE>   75

                            PMC CAPITAL L.P. 1998-1
                         NOTES TO FINANCIAL STATEMENTS

NOTE 1.  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: (CONTINUED)

         STATEMENT OF CASH FLOWS

         The Company considers all highly liquid investments purchased with an
         original maturity of three months or less to be cash equivalents for
         purposes of the statement of cash flows.

NOTE 2.  LOANS RECEIVABLE:

         On November 24, 1998, PMC Capital either contributed or sold the
         aggregate amount of $43.4 million of loans (the "Partnership Loans")
         to the Partnership without recourse to PMC Capital.

         At December 31, 1998 their were no recorded investment in loans
         identified as impaired.

         The Company's portfolio of investments consists of loans to borrowers
         located principally in the southern portion of the United States. The
         most significant concentration of loans were as noted below:

<TABLE>
<CAPTION>
                                                 Percentage of Loan Portfolio
               State                                  December 31, 1998
               -----                             ----------------------------
               <S>                               <C>

               Texas                                          23%
               Arizona                                         9%
               South Carolina                                  7%
               Georgia                                         7%
               Other                                          54%
                                                             ---
                                                             100%
                                                             === 
</TABLE>

         There were no loans receivable; (i) greater than 60 days past due,
         (ii) on which litigation against the borrowers had commenced, or (iii)
         which were in the process of liquidation at December 31, 1998.


NOTE 3.  CREDIT RISK:

         At December 31, 1998 loans to businesses in the lodging industry
         comprised 73% of loans receivable and 64% of total assets. There can
         be no assurance that the Partnership will experience the positive
         results which PMC Capital has historically achieved from these lending
         activities. Any economic factors that negatively impact the lodging
         industry could have a material adverse effect on the business of the
         Partnership. Additionally, at December 31, 1998 loans to businesses
         located in Texas comprised approximately 23% of the Partnership's
         outstanding loan portfolio. No other state had a concentration greater
         than 10%. A decline in economic conditions in Texas may adversely 
         affect the Partnership.


                                     F-48

<PAGE>   76

                            PMC CAPITAL L.P. 1998-1
                         NOTES TO FINANCIAL STATEMENTS

NOTE 4.  NOTES PAYABLE:

         On November 24, 1998, the Partnership completed a private placement of
         approximately $39.6 million of its Loan-Backed Adjustable Rate Class-A
         Notes, (the "Class-A Notes") and $2.2 million of its Loan-Backed
         Adjustable Rate Class-B Notes (the "Class-B Notes", and together with
         the Class-A Notes, the "Notes"). The Class-A Notes and the Class-B
         Notes, issued at par, which have a stated maturity in 2021 and bear
         interest at the prime rate less 1.0% and 0.9%, respectively, are
         collateralized by the loans contributed by PMC Capital to the
         Partnership. In connection with this private placement, the Class-A
         Notes and the Class-B Notes were given a rating of "Aaa" and "A1",
         respectively, by Moody's Investors Service. The Class-B Notes were
         purchased by PMC Capital, Inc., the limited partner of the
         Partnership. The Partnership has the exclusive obligation for the
         repayment of the Notes, and the holders of the Notes have no recourse
         to PMC Capital or its other subsidiaries or their assets in the event
         of nonpayment of the loans. Required principal payments to the
         noteholders are based upon the collection of principal on the
         Partnership Loans. All principal collected on the Partnership Loans
         during the monthly period (as defined in the Trust Indenture) are used
         to make the required principal payment on the first business day of
         the following month.

NOTE 5.  PARTNERS' CAPITAL:

         The net proceeds from the issuance of the Notes (approximately $39.8
         million prior to the payment of issuance costs of approximately
         $500,000 and the funding of a $2.6 million reserve fund held by the
         trustee as collateral) were distributed to PMC Capital.

NOTE 6.  FAIR VALUES OF FINANCIAL INSTRUMENTS:

         The estimates of fair value as required by Statement of Financial
         Accounting Standards ("SFAS") No. 107 do not differ from the value of
         the financial assets and liabilities determined by the General Partner
         primarily as a result of the recent completion of the asset purchase
         at fair value and the portfolio assets having variable rates of
         interest. Considerable judgement is required to interpret market data
         and develop the estimates of fair value. Accordingly, the estimates
         presented herein are not necessarily indicative of the amounts the
         Partnership could realize in a current market exchange or the amount
         that ultimately will be realized by the Partnership upon maturity or
         disposition.

         The estimated fair values of the Partnership's financial instruments
         pursuant to SFAS No. 107 are as follows:

<TABLE>
<CAPTION>
                                                         1998         
                                              --------------------------
                                                               Estimated
                                              Carrying           Fair
                                               Amount            Value
                                              --------         ---------
                                                   (in thousands)
<S>                                           <C>              <C>     
           Assets:
              Loans receivable, net           $ 41,255         $ 41,255
              Restricted investments             5,898            5,898

           Liabilities:
              Notes payable                     40,983           40,983
</TABLE>

         Loans receivable, net: The estimated fair value for all loans is
         estimated by discounting the estimated cash flows using the current
         rate at which similar loans would be made to borrowers with similar
         credit ratings and maturities. The impact of delinquent loans on the
         estimation of the fair values described above is not considered to
         have a material effect and accordingly, delinquent loans have been
         disregarded in the valuation methodologies employed.


                                     F-49
<PAGE>   77

                            PMC CAPITAL L. P. 1998-1
                         NOTES TO FINANCIAL STATEMENTS

NOTE 6.  FAIR VALUES OF FINANCIAL INSTRUMENTS: (CONTINUED)

         Restricted investments : The carrying amount is a reasonable
         estimation of fair value.

         Notes payable: The estimated fair value is based on present value
         calculation using prices of the same or similar instruments after
         considering risk, current interest rates and remaining maturities.

NOTE 7.  RELATED PARTY TRANSACTIONS:

         At December 31, 1998, the balance in due to affiliates of $450,000 was
         a result of interest transferred to the Partnership relating to loans
         receivable. These balances will be repaid subsequent to year end.


                                     F-50

<PAGE>   78

                                    EXHIBITS

<TABLE>
<CAPTION>
         Exhibit  Description                                                       Page
         -------  -----------                                                       ----
         <S>      <C>                                                               <C>

         3.1      Articles of Incorporation, as amended (incorporated by
                  reference to Exhibit 4(b)(1) to Amendment No. 9 to the
                  Registration Statement on Form N-2 (Registration No. 33-2535)
                  (the "N-2 Registration Statement"), dated November 29, 1991.

         3.2      By-Laws, as amended (incorporated by reference to Exhibit 2
                  to Amendment No.7 to the N-2 Registration Statement dated
                  April 27, 1989).

         4.1      Certificate of Common Stock (incorporated by reference to
                  Exhibit 4 to Amendment No. 1 to the N-2 Registration
                  Statement dated November 10, 1993).

     ****4.2      Debenture dated September 24, 1996 for $2,490,000 loan with
                  SBA.

         4.5      Debenture dated June 27, 1990 for $2,000,000 loan with SBA -
                  (incorporated by reference from Exhibit 4(b)(5)(n)
                  Registrant's Form N-2, Amendment No. 9, dated April 29,
                  1991).

         4.6      Debenture dated September 26, 1990 for $2,810,000 loan with
                  SBA - (incorporated by reference from Exhibit 4(b)(5)(o) to
                  the Registrant's Form N-2, Amendment 9, dated April 29,
                  1991).

         4.7      Debenture dated September 26, 1990 for $1,500,000 loan with
                  SBA - (incorporated by reference from Exhibit 4(b)(5)(p) to
                  the Registrant's Form N-2, Amendment 9, dated April 29,
                  1991).

         4.8      Debenture dated March 29, 1990 for $1,000,000 loan with SBA -
                  (incorporated by reference from Exhibit 5(q) from
                  Registrant's Form N-2, Amendment No. 3, dated August 18,
                  1992).

         4.9      Debenture dated September 27, 1989 for $1,000,000 loan with
                  SBA - (incorporated by reference from Exhibit 5(r) from
                  Registrant's Form N-2, Amendment No. 3, dated August 18,
                  1992).

         4.10     Debenture dated September 27, 1989 for $1,500,000 loan with
                  SBA - (incorporated by reference from Exhibit 5(s) from
                  Registrant's Form N-2, Amendment No. 3, dated August 18,
                  1992).
</TABLE>


                                      E-1
<PAGE>   79

         4.11     Debenture dated January 2, 1990 for $3,000,000 loan with SBA
                  - (incorporated by reference from Exhibit (5)(t) from
                  Registrant's Form N-2, Amendment No. 3, dated August 18,
                  1992).

         4.12     Debenture dated August 18, 1989 for $1,000,000 loan with SBA
                  - (incorporated by reference from Exhibit (5)(u) from
                  Registrant's Form N-2, Amendment No. 3, dated August 18,
                  1992).

       **4.13     Debenture dated September 28, 1994 for $3,000,000 loan with
                  SBA.

       **4.14     Debenture dated September 28, 1994 for $3,000,000 loan with
                  SBA.

       **4.15     Senior Note dated July 19, 1993 for $6,000,000 with Columbine
                  Life Insurance Company.

       **4.16     Senior Note dated July 19, 1993 for $9,000,000 with Life
                  Insurance Company of Georgia.

       **4.17     Senior Note dated July 19, 1993 for $5,000,000 with SouthLand
                  Life Insurance Company.

       **4.18     Senior Note dated December 15, 1993 for $2,000,000 with
                  Peerless Insurance Company.

       **4.19     Senior Note dated December 15, 1993 for $3,000,000 with
                  Security Life of Denver Insurance Company.

      ***4.20     Debenture dated March 29, 1995 for $3,000,000 loan with SBA.

      ***4.21     Debenture dated June 28, 1995 for $5,000,000 loan with SBA.

      ***4.22     Debenture dated September 27, 1995 for $7,000,000 loan with
                  SBA.

      ***4.24     Debenture dated December 20, 1989 for $650,000 loan with SBA
                  assumed from J & D Capital Corporation.

      ***4.25     Debenture dated June 27,1990 for $300,000 loan with SBA
                  assumed from J & D Capital Corporation.

      ***4.26     Debenture dated December 6, 1992 for $510,000 loan with SBA
                  assumed from J & D Capital Corporation.

      ***4.27     Senior Note dated April 19, 1995 for $5,000,000 with Security
                  Life of Denver Insurance Company.

      ***4.28     Senior Note dated April 19, 1995 for $2,000,000 with Peerless
                  Insurance Company.


                                      E-2
<PAGE>   80

      ***4.29     Senior Note dated April 19, 1995 for $2,000,000 with Indiana
                  Insurance Company.

      ***4.30     Senior Note dated April 19, 1995 for $1,000,000 with Security
                  Life of Denver Insurance Company.

     ****4.31     Debenture dated June 27, 1990 for $1,030,000 assumed from
                  ESLO Capital Corporation.

        *10.1     Employment contract between the Registrant and Lance B.
                  Rosemore dated July 1, 1998.

        *10.2     Employment contract between the Registrant and Andrew S.
                  Rosemore dated July 1, 1998.

     ****10.3     Employment contract between the Registrant and Fredric M.
                  Rosemore dated June 30, 1996.

        *10.4     Employment contract between the Registrant and Jan F. Salit
                  dated July 1, 1998.

        *10.5     Employment contract between the Registrant and Barry N.
                  Berlin dated July 1, 1998.

        *10.6     Employment contract between the Registrant and Mary J.
                  Brownmiller dated July 1, 1998.

         10.7     First Amended and Restated Revolving Credit Note dated as 
                  of March 15, 1998 - (incorporated by reference from 
                  Registrants' Form 10-Q for the quarterly period ended 
                  March 31, 1998).

     ****10.8     Servicing Agreement by and among Sun Trust Bank, PMC Capital
                  Limited Partnership and PMC Capital, Inc.

    *****10.9     PMC Capital, Inc. 1997 Non-Employee Stock Option Plan.

    *****10.10    PMC Capital, Inc. 1997 Employee Stock Option Plan.

        *10.11    Employment contract between the Registrant and Cheryl T.
                  Murray dated July 1, 1998.

        *10.12    Servicing Agreement by and among Harris Trust, PMC Capital
                  L.P. 1998-1, and PMC Capital, Inc.

         10.13    Second Amendment to Loan Agreement and Amendment to Loan
                  Documents and Renewal and Extension of loan dated as of March
                  15, 1998 - (incorporated by reference from Registrant's Form
                  10-Q for the quarterly period ended March 31, 1998).

        *21       Subsidiaries of Registrant

        *27       Financial Data Schedule

                  -------------------
                  *      Filed herewith
                  **     Previously filed with the Commission as an exhibit to
                         the Registrant's Form 10-K for the fiscal year ended 
                         December 31, 1994
                  ***    Previously filed with the Commission as an exhibit to 
                         the Registrant's Form 10-K for the fiscal year ended 
                         December 31, 1995
                  ****   Previously filed with the Commission as an exhibit to 
                         the Registrant's Form 10-K for the fiscal year ended
                         December 31, 1996
                  *****  Previously filed with the Commission as an exhibit to 
                         the Registrant's Form 10-K for the fiscal year ended 
                         December 31, 1997


                                      E-3