<PAGE>   1
                                                                      EXHIBIT 13

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


OVERVIEW

Community Financial Group, Inc. (CFGI) is a registered bank holding company
under the Federal Bank Holding Company Act of 1956, as amended, and owns 100% of
the outstanding capital stock of The Bank of Nashville (The Bank). CFGI and its
subsidiary, The Bank, are collectively referred to as the Company. The Bank is a
state chartered bank incorporated in 1989 under the laws of the State of
Tennessee. On April 30, 1996, CFGI executed a plan of exchange with The Bank,
whereby CFGI became the parent bank holding company of The Bank. Under the
agreement, each share of the common stock of The Bank was exchanged for one
share of CFGI, and each outstanding warrant and each outstanding option to
purchase common shares of The Bank automatically became warrants and options to
purchase shares of CFGI. The Company experienced a significant change in its
capital structure in 1998 as 2.0 million warrants, each representing the right
to acquire a common share at a price of $12.50, were exercised. In 1998,
proceeds generated from the exercise of the warrants totaled $25.0 million and
the Company ended the year with 4.2 million common shares outstanding. All
warrants expired on December 31, 1998. In January, 1998, the Company's Board of
Directors adopted a Shareholder Rights Plan which authorizes the distribution of
a dividend of one common share purchase right for each outstanding share of
CFGI's common stock. The rights will be exercisable only if a person or group
acquires 15% or more of CFGI's common stock or announces a tender offer, the
consummation of which will result in ownership by a person or group of 15% or
more of the common stock. The rights are designed to ensure that all of CFGI's
shareholders receive fair and equal treatment in the event of any proposed
takeover of the Company and to guard against partial tender offers, squeeze
outs, open market accumulations, and other abusive tactics to gain control of
the Company without paying all shareholders an appropriate control premium. The
holding company's structure, as well as the influx of additional capital that
occurred in 1998, provide flexibility for expansion of the Company's banking
business through acquisition of other financial institutions and/or for the
addition of banking related services which traditional commercial banks are
prohibited from providing under current law.

The accompanying consolidated financial statements and notes are considered to
be an integral part of this analysis and should be read in conjunction with the
narrative. This discussion and analysis is intended to supplement and highlight
information contained in the accompanying consolidated financial statements and
the selected financial data presented elsewhere in this report. To the extent
that the statements in this discussion relate to the plans, objectives, or
future performance of the Company, these statements may be deemed to be forward
looking statements within the meaning of the Private Securities Litigation
Reform Act of 1995. Such statements are based on management's current
expectations and the current economic environment. Actual strategies and results
of future periods may differ materially from those currently expected due to
various risks and uncertainties.

The Company's primary base of operations is located in the L&C Tower at 401
Church Street, Nashville, Tennessee, 37219. The Bank has two full service
traditional branches, one located at the Glendale Center in Green Hills, which
opened in January, 1997 and the other located in Maryland Farms in Brentwood,
which opened in September, 1998. Additional branch services are provided through
full service mobile branching, "Bank-on-Call", which was established in
September, 1996 and which has expanded in each subsequent year. Bank-on-Call
provides the convenience of "at your door" banking service to customers.
Additionally, the Company has expanded its delivery systems through full service
ATMs, cash dispensers, cash management services, and now its soon to be
introduced, "Bank-on-Line" Internet banking service.



                                      -7-
<PAGE>   2


Additional expansion plans include a branch in Hendersonville, Tennessee
currently under construction with a planned opening in the late spring of 1999.
During 1998, the Company discontinued most services offered through the Trust
Division while expanding the Investment Services Division provided with LM
Financial Partners, Inc. The addition of two investment advisors and their
support staff at the Green Hills Office to offer LM Financial Partners, Inc.
investment services during the second quarter of 1998 has resulted in a net
contribution to the Company's earnings. The Company offers a full array of
commercial and consumer banking services, as well as investment services.

The primary service area of the Company is centered around Nashville, Tennessee
and encompasses an eight county area. The Company competes with existing area
commercial banks and other area financial institutions, including savings and
loan associations, insurance companies, consumer finance companies, brokerage
firms, credit unions and other business entities which have been active in
pursuing traditional banking markets. Due to the rapid economic growth in the
Company's market area, additional competition is expected to continue from new
entrants to the market. Although the Company has fewer physical locations than
many of its competitors, it has continued its commitment to providing customers
with maximum convenience by allowing them to access their accounts through
competitors' ATMs throughout the State of Tennessee at no charge. This is
accomplished through a program whereby the Company rebates any surcharges
imposed on its customers by ATM providers within the State of Tennessee when
accessed by a Bank of Nashville ATM or MasterMoney card.

The Company's assets were $238.2 million at December 31, 1998, compared to
$204.9 million at December 31, 1997, representing an increase of 16.3%.
Shareholders' equity increased $27.1 million, an increase of 112.8% from the
$24.1 million at December 31, 1997. This increase included $25.0 million in
equity capital resulting from the exercise of warrants during 1998. During 1998,
shareholders were paid $.24 per share through four quarterly dividends of $.06
each compared to dividends totaling $.20 per share in 1997. The Company reported
earnings of $2.6 million, or basic earnings per share of $1.08 in 1998 compared
to $2.1 million, or $.93 basic earnings per share in 1997. Diluted earnings per
share were $.78 in 1998 compared to $.89 in 1997. The decrease in diluted
earnings per share resulted from the warrants outstanding during 1998, all of
which were either exercised or expired at December 31, 1998. The increased
number of shares outstanding resulting from the exercise of warrants will reduce
basic earnings per share on a comparative basis until the Company has the
opportunity to more effectively employ the additional capital to enhance
profitability. Return on average shareholders' equity (exclusive of other
comprehensive income) was 9.56% in 1998 compared to 9.05% in 1997, while the
return on average assets for 1998 and 1997 were 1.23% and 1.08%, respectively.
During 1998, the Company continued its focus on asset quality while expanding
its service locations and product lines in accordance with its long-term
strategic plan. The maintenance of an adequate level for the allowance for loan
losses was reflected by a provision for loan losses of $128,000 being reported
in 1998, a period in which net recoveries were $390,000. This provision expense
was deemed to be prudent given the Company's loan growth despite a decline of
$767,000 in the level of nonperforming assets at year end 1998 when compared to
the same period in 1997. The Company recorded $100,000 in 1997 for provision for
loan loss, a period in which net recoveries were $150,000. During 1998, net
nonperforming assets decreased $767,000, or 62.5%, to $460,000 from $1.2 million
at year end 1997, while total loans increased $29.9 million, or 24.4%, from
$122.7 million at December 31, 1997 to $152.7 million at year end 1998. A more
detailed analysis of nonperforming assets



                                      -8-
<PAGE>   3


and the provision for loan losses is presented under the caption, "Provision for
Loan Losses" and "Nonperforming Assets and Risk Elements". During 1998, deposits
declined $1.5 million, or .9%, to $162.6 million at December 31, 1998 from
$164.1 million at year end 1997; however, average deposits increased $14.7
million, or 9.6%, in 1998 compared to 1997. The decline in total deposits at
year-end, 1998, was reflected in higher rate time certificates and money market
accounts while non-interest bearing demand deposits and NOW accounts reflected
significant growth compared to year-end 1997. The net loan to deposit ratio at
December 31, 1998, was 93.9% while the net loans to asset ratio was 64.1%.
Additional capital generated from the exercise of warrants allowed the Company
to be less aggressive in rates offered for time certificates of deposit to
non-relationship customers during late 1998.

NET INTEREST INCOME

Fluctuations in interest rates, as well as changes in the volume or mix of
earning assets and interest bearing liabilities, can materially impact net
interest income.

Net interest income increased 17.1% to $8.6 million in 1998 from $7.3 million in
1997. Total interest income increased $1.3 million, or 8.7%, in 1998 compared to
1997, while total interest expense increased $.1 million, or 1.0%, compared to
1997. The increase in total interest income is attributable primarily to an 8.5%
increase in average earning assets and a shift in the mix of these assets as the
growth was comprised primarily of an $18.8 million increase in average loans.
This increase in loans was partially offset by a decline of $2.5 million in the
volume of average investments and $.6 million in other earning asset categories.
Additionally, the rate earned on average earning assets in 1998 increased two
basis points when compared to 1997, reflecting a shift in the mix of these
assets as loans, the Company's highest yielding asset, reflected an increase
while other categories declined. Average interest bearing liabilities increased
$11.9 million, or 7.9%, in 1998 compared to 1997. This increase in average
interest bearing liabilities was comprised of a $10.8 million increase in
average money market accounts, $4.3 million in average NOW accounts and $.9
million in CDs $100,000 or greater while CDs less than $100,000 declined $3.6
million and Federal Home Loan Bank and other borrowings declined $.4 million.
The average rate paid on interest bearing liabilities decreased 34 basis points
in 1998 compared to 1997. The decline in rates paid was reflected in all
categories of interest bearing liabilities. The following two schedules present
an analysis of net interest income and the detail of income due to the
fluctuations in volumes and rates.



                                      -9-
<PAGE>   4


AVERAGE BALANCE SHEETS AND NET INTEREST INCOME ANALYSIS


<TABLE>
<CAPTION>
                                                             1998                                      1997
                                           -------------------------------------      ---------------------------------------
                                                           Interest      Average                      Interest        Average
                                           Average         Income/       Yields/      Average         Income/         Yields/
                                           Balance         Expense*       Rates*      Balance         Expense*         Rates*
(Dollars In Thousands)
---------------------------------------------------------------------------------------------------------------------------
<S>                                       <C>             <C>            <C>          <C>             <C>             <C>
ASSETS
Loans (net of unearned income):
     Commercial                           $ 43,137        $ 3,983         9.23%       $ 36,889        $ 3,438          9.32%
     Real Estate - mortgage                 72,627          6,649         9.15          65,102          6,002          9.22
     Real Estate - construction             12,288          1,132         9.21           9,102            849          9.33
     Consumer                                5,608            627        11.18           3,742            435         11.62
---------------------------------------------------------------------------------------------------------------------------
         Total loans (net of
           unearned income)                133,660         12,391         9.27         114,835         10,724          9.34
---------------------------------------------------------------------------------------------------------------------------
Securities                                  59,117          3,833         6.48          61,587          4,128          6.70
Due from banks                                 163             10         5.84             333             19          5.75
Federal funds sold                           7,305            374         5.13           7,772            398          5.12
---------------------------------------------------------------------------------------------------------------------------
         Total earning assets             $200,245        $16,608         8.29%       $184,527        $15,269          8.27%

Allowance for loan losses                   (3,389)                                     (3,006)
Cash and due from banks                      9,449                                       6,633
Premises and equipment, net                  1,670                                       1,040
Accrued interest and other assets            1,526                                       1,572
---------------------------------------------------------------------------------------------------------------------------

         Total assets                     $209,501                                    $190,766
===========================================================================================================================

LIABILITIES AND SHAREHOLDERS' EQUITY
NOW accounts                              $ 11,190        $   367         3.28%       $  6,856        $   253          3.69%
Money market accounts                       77,982          3,463         4.44          67,216          3,205          4.77
Time certificates less
  than $100,000                             31,551          1,809         5.73          35,186          2,061          5.86
Time certificates
  $100,000 and greater                      30,162          1,692         5.61          29,294          1,693          5.78
Federal Home Loan Bank and
  other borrowings                          12,718            704         5.54          13,124            744          5.67
---------------------------------------------------------------------------------------------------------------------------
         Total interest-bearing
          liabilities                     $163,603        $ 8,035         4.91%       $151,676        $ 7,956          5.25%

Non-interest bearing demand
  deposits                                  16,409                                      14,088
Accounts payable and accrued
  liabilities                                2,176                                       2,156
---------------------------------------------------------------------------------------------------------------------------
         Total liabilities                 182,188                                     167,920
---------------------------------------------------------------------------------------------------------------------------

Shareholders' equity                        27,313                                      22,846
---------------------------------------------------------------------------------------------------------------------------
         Total liabilities and
          shareholders' equity            $209,501                                    $190,766
===========================================================================================================================

Interest income/earning assets*                                           8.29%                                        8.27%
Interest expense/earning assets                                           4.01                                         4.31
---------------------------------------------------------------------------------------------------------------------------
Net interest margin*                                                      4.28%                                        3.96%
===========================================================================================================================
</TABLE>

* Fully taxable equivalent basis.

Nonaccrual loans are included in average loans and average earning assets.
Consequently, yields on these items are lower than they would have been if all
loans had earned at their contractual rate of interest. Had nonaccrual loans
earned income at the contractual rate, interest income of $29,000 and $32,000
would have been recognized during 1998 and 1997, respectively.



                                      -10-
<PAGE>   5


ANALYSIS OF CHANGES IN NET INTEREST INCOME

<TABLE>
<CAPTION>
                                                 1998 Compared to 1997                1997 Compared to 1996
                                          Increase   (Decrease)      Due to      Increase   (Decrease)    Due to
(In Thousands)(1)                           Rate       Volume          Net         Rate       Volume        Net
----------------------------------------------------------------------------------------------------------------
<S>                                       <C>        <C>             <C>         <C>        <C>           <C>
INTEREST INCOME:
     Loans                                 $ (78)      $ 1,745       $ 1,667       $ 41       $1,114      $1,155
     Securities                             (131)         (164)         (295)         5        1,107       1,112
     Due from banks                           --            (9)           (9)        --           19          19
     Federal funds sold                        1           (25)          (24)        16           68          84
----------------------------------------------------------------------------------------------------------------

         Total Interest Income              (208)        1,547         1,339         62        2,308       2,370
----------------------------------------------------------------------------------------------------------------

INTEREST EXPENSE:
     NOW accounts                            (31)          145           114         77           36         113
     Money market accounts                  (231)          489           258         12          380         392
     Time certificates under $100,000        (45)         (207)         (252)       (23)         302         279
     Time certificates $100,000
       and over                              (50)           49            (1)        22          108         130
     Federal Home Loan Bank
       and other borrowings                  (22)          (18)          (40)         9          587         596
----------------------------------------------------------------------------------------------------------------

         Total Interest Expense             (379)          458            79         97        1,413       1,510
----------------------------------------------------------------------------------------------------------------

         NET INTEREST INCOME               $ 171       $ 1,089       $ 1,260       $(35)      $  895      $  860
================================================================================================================
</TABLE>

(1)    Changes in net interest income are attributed to either changes in
       average balances (volume change) or changes in average rates (rate
       change) for earning assets and sources of funds on which interest is
       received or paid. These rates are calculated on a fully taxable
       equivalent basis. Volume change is calculated as change in volume
       multiplied by the old rate while rate change is change in rate multiplied
       by the old volume. The rate/volume change is allocated between volume
       change and rate change at the ratio each component bears to the absolute
       value of their total. Nonaccrual and 90 days or more past due loans are
       included in average loans for which changes due to rates and volume are
       computed.

Trends in net interest income are commonly evaluated in terms of average rates,
using the net interest margin and the net interest spread. The interest margin,
or the net yield on earning assets, is computed by dividing net interest income
by average earning assets. This ratio represents the difference between the
average yield on average earning assets and the average rate paid for all funds
used to support those earning assets, including both interest bearing and
non-interest bearing sources of funds. The Company's net interest margin
increased by 32 basis points to 4.28% in 1998, primarily as a result of a shift
in the mix of earning assets from investments to higher yielding loans combined
with an overall decrease in deposit rates paid during 1998. A higher average
loan to deposit ratio also contributed to the improvement in the net interest
margin in 1998 compared to 1997.

Changes in the mix of earning assets or supporting liabilities can either
increase or decrease the net interest margin without affecting interest rate
sensitivity. In addition, the interest rate spread between an asset and its
supporting liability can vary significantly, while the timing for repricing of
both the asset and liability remain the same; both impact net interest income.
It should be noted, therefore, that a matched interest sensitivity position, by
itself, will not ensure maximum net interest income. Management continually
evaluates the condition of the economy, the pattern of market interest rates and
other economic data to determine the types of investments that should be made
and at what maturity. Using this analysis, management from time to time assumes
calculated interest sensitivity gap positions to maximize net interest income
based upon anticipated movements in the general level of interest rates. The
Company's "negative gap" position in the short term (one year or less) currently
positions it to benefit from a declining interest rate environment. "Negative
gap" is used to describe the interest sensitivity position when a company's rate
sensitive liabilities are repricing faster than its rate sensitive assets. See
"Liquidity and Asset/Liability" section.



                                      -11-
<PAGE>   6


The interest rate spread measures the difference between the average yield on
earning assets and the average rate paid on interest bearing sources of funds.
The interest rate spread eliminates the impact of non-interest bearing funds and
gives a direct perspective on the effect of the market interest rate movement.
During 1998, the interest rate spread increased compared with 1997. The
following table presents an analysis of the Company's interest rate spread and
net yield on earning assets.

<TABLE>
<CAPTION>
                                                         Years Ended December 31
                                                           1998          1997
--------------------------------------------------------------------------------
         <S>                                               <C>           <C>
         Rate earned on interest earnings assets           8.29%         8.27%
         Rate paid on interest bearing liabilities         4.91%         5.25%
         Interest rate spread                              3.38%         3.02%
         Net yield on earnings assets                      4.28%         3.96%
</TABLE>

The shift in mix of earning assets together with the increased level of earning
assets and the decline in the average rate paid on interest bearing liabilities
resulted in a higher level of net interest income. The positive impact of the
increased level of earning assets particularly in the area of loans was somewhat
offset by growth in interest bearing liabilities.

PROVISION FOR LOAN LOSSES

The Company maintains an allowance for loan losses at a level, which, in
management's evaluation, is adequate to cover estimated losses on loans based on
available information at the end of each reporting period. Considerations in
establishing the allowance include historical net charge-offs, changes in the
credit risk, mix and volume of the loan portfolio, and other relevant factors,
such as the risk of loss on particular loans, the level of nonperforming assets,
and current and forecasted economic conditions. A more detailed discussion of
nonperforming assets is presented under the caption "Nonperforming Assets and
Risk Elements".

In 1998, the Company recorded $128,000 in expense for provision for loan losses,
compared with $100,000 in 1997. This provision for loan losses was deemed
appropriate due to the growth in the loan portfolio despite net recoveries for
1998 and a decline in nonperforming assets. Net recoveries were $390,000 in 1998
compared to $150,000 in 1997. The allowance for loan losses was 2.4% of loans at
December 31, 1998, compared to 2.5% of loans at the same date in 1997. This
decline in percentage resulted from a 24.4% increase in the loan portfolio. Net
recoveries of $390,000 in 1998 resulted from charge-offs of $84,000 and
recoveries of $474,000 reflecting continued collection efforts on loans charged
off in prior periods. In 1997, net recoveries of $150,000 were the result of
charge-offs of $169,000 and recoveries of $319,000.

Management will continue to evaluate the level of the allowance for loan losses
and will determine what additional adjustments, if any, are necessary. Continued
growth in the loan portfolio will be a factor in this evaluation, as well as the
quality of the loan portfolio and other external and internal factors. The level
of the allowance and the amount of the provision are determined on a quarter by
quarter basis and, given the inherent uncertainties involved in the estimation
process, no assurance can be given as to the amount of the provision and the
level of the allowance at any future date. Management anticipates there will be
continued provision expense in 1999; however, the specific amount will be
determined on a quarter by quarter basis as all factors are evaluated. Changes
in circumstances affecting the various factors considered by the Company in
establishing the level of the allowance could significantly affect the amount of
the provision that is deemed to be warranted.



                                      -12-
<PAGE>   7


As a financial institution that assumes lending and credit risks as a principal
element of its business, the Company anticipates that credit losses will be
experienced in the normal course of business. Accordingly, the Company
consistently applies a comprehensive methodology and procedural discipline which
is updated on a quarterly basis at the subsidiary bank level to determine both
the adequacy of the allowance for loan losses and the necessity for charging
provisions against earnings. The allowance for loan losses is based on
assessments of the probable estimated losses inherent in the loan portfolio. The
allowance for loan losses is comprised of an allocated and unallocated portion.
Both portions of the allowance are available to support inherent losses in the
portfolio. The allocated allowance is determined for each classification of both
performing and nonperforming loans within the portfolio. This methodology
includes:

-     The application of allowance allocations for commercial loans, consumer
      loans, and real estate loans are calculated by using weighted-average loss
      rates over a defined time horizon based upon analysis of the Company's
      historical averages of actual net loan charge-offs incurred within the
      loan portfolios by loan quality grade. The Company has established minimum
      loss factors for certain loan grade categories.

-     A detailed review of all criticized, nonperforming, and impaired loans to
      determine if any specific allowance allocations are required on an
      individual loan where management has identified significant conditions or
      circumstances exist that indicate the probability that a loss may be
      incurred in excess of the amount determined by the application of the
      historical loss methodology.

The unallocated allowance is established for loss exposure that may exist in the
remainder of the loan portfolio but has yet to be identified and to compensate
for the uncertainty in estimating loan losses, including the possibility of
changes in risk ratings of loans. The unallocated allowance is based upon
management's evaluation of various conditions, the effects of which are not
directly measured in determining the allocated allowance. The evaluation of the
inherent loss related to these conditions involves a higher degree of
uncertainty because they are not associated with specific problem credits or
portfolio segments. The unallocated allowance represents prudent recognition of
the fact that allowance estimates, by definition, lack precision. The conditions
evaluated in connection with the unallocated allowance include the following
conditions as of the balance sheet date:

-     Changes in lending policies and procedures
-     National and local economic conditions
-     Trends in loan volumes and terms of loans in the portfolio
-     Changes in experience of personnel
-     Recent levels of, and trends in, delinquencies and non-accruals
-     Loan review evaluation of the credit process
-     Credit concentrations
-     Competition, legal, and regulatory requirements
-     Peer comparisons

Management reviews these conditions quarterly in discussion with its loan
officers. If any of these conditions is evidenced by a specifically identifiable
problem loan or portfolio segment as of the evaluation date, management's
estimate of the effect of this condition may be reflected in the allocated
allowance applicable to the loan or portfolio segment. Where a specifically
identifiable problem loan or portfolio segment as of the evaluation date does
not evidence any of these conditions, management's evaluation of the probable
loss concerning this condition is reflected in the unallocated allowance.
Management believes that in most instances, the impact of these events on the
collectibility of the applicable loans has not yet been reflected in the level
of nonperforming loans or in the internal risk grading process regarding these
loans. Accordingly, our evaluation of the probable losses related to these
factors is reflected in the unallocated allowance.



                                      -13-
<PAGE>   8


The Company does not weight the unallocated allowance among segments of the
portfolio. The following specific factors are reflected in management's estimate
of the unallocated allowance:

-     Concentration of real estate dependent loans
-     Declining performance in certain industries such as healthcare and
      construction

While the Company's rate of charge-offs is low and net recoveries have been
realized, management is aware that the Company has been operating in an
extremely beneficial economic environment. Management of the Company, along with
a number of economists, perceives increasing instability in the national and
mid-south economies and a worldwide economic slowdown that could contribute to
job losses and otherwise adversely affect a broad variety of business sectors in
our markets. Also, by virtue of its increased capital levels, the Company is
able to make larger loans, thereby increasing the possibility of a loan having a
larger adverse impact than before. Accordingly, management believes that the
maintenance of an unallocated allowance in the current amount is prudent and
consistent with regulatory requirements.

After completion of this process, a Board of Directors meeting is held to
evaluate the adequacy of the allowance and establish the provision level for the
current quarter. The Company believes that the procedural discipline, systematic
methodology, and comprehensive documentation of this quarterly process is in
full compliance with all regulatory requirements and provides appropriate
support for accounting and reporting purposes. The Company believes that the
allocation of its allowance for loan losses is reasonable.



                                      -14-
<PAGE>   9


The following table represents a recap of activity in the allowance for loan
losses during the past two years.

SUMMARY OF LOAN LOSS EXPERIENCE


<TABLE>
<CAPTION>
(In Thousands)                                                 1998             1997
--------------------------------------------------------------------------------------
<S>                                                          <C>              <C>
ALLOWANCE FOR LOAN LOSSES, JANUARY 1                         $  3,128         $  2,878

LOANS CHARGED OFF:
   Commercial                                                     (41)            (169)
   Real estate                                                    (38)              --
   Consumer                                                        (5)              --
--------------------------------------------------------------------------------------

      Total charge-offs                                           (84)            (169)
--------------------------------------------------------------------------------------

RECOVERIES OF LOANS PREVIOUSLY CHARGED OFF:
   Commercial                                                     222              317
   Real estate                                                      2               --
   Consumer                                                       250                2
--------------------------------------------------------------------------------------

      Total recoveries                                            474              319
--------------------------------------------------------------------------------------

NET RECOVERIES                                                    390              150
--------------------------------------------------------------------------------------

PROVISION CHARGED TO OPERATIONS                                   128              100
--------------------------------------------------------------------------------------

ALLOWANCE FOR LOAN LOSSES, DECEMBER 31                       $  3,646         $  3,128
======================================================================================

Loans, net of unearned income
   Year-end                                                  $152,675         $122,749
   Average during year                                       $133,660         $114,835

Allowance for loan losses to year-end
   loans, net of unearned income                                  2.4%             2.5%

Provision for loan losses to average
   loans, net of unearned income                                   .1%              .1%

Net recoveries to average loans, net of unearned income            .3%              .1%
</TABLE>


The following table presents the allocation of the allowance for loan losses for
the past two years.

ALLOCATION OF THE ALLOWANCE LOAN FOR LOSSES


<TABLE>
<CAPTION>
(In Thousands)                                     1998         1997
--------------------------------------------------------------------------------
<S>                                              <C>            <C>
BALANCE APPLICABLE TO:
   Commercial                                    $    918       $  916
   Real estate - mortgage loans                     1,006          967
   Real estate - construction loans                   133          128
   Consumer                                            47           79
   Unallocated                                      1,542        1,038
--------------------------------------------------------------------------------

                                                 $  3,646       $3,128
================================================================================

PERCENT OF TOTAL ALLOCATION
   Commercial                                        25.2%        29.3%
   Real estate - mortgage loans                      27.6         30.9
   Real estate - construction loans                   3.6          4.1
   Consumer                                           1.3          2.5
   Unallocated                                       42.3         33.2
--------------------------------------------------------------------------------

                                                    100.0%       100.0%
================================================================================
</TABLE>



                                      -15-
<PAGE>   10


NON-INTEREST INCOME

Total non-interest income was $1.8 million in 1998, reflecting an increase of
27.0% from $1.4 million reported in 1997. Non-interest income, less
non-recurring income (gains/losses on sale of securities and other real estate),
increased $311,000, or 22.0%, from 1997. Investment center income increased
$555,000 as the Company expanded its arrangement with LM Financial Partners,
Inc. to offer certain investment services through the addition of two investment
advisors at the Green Hills Office in May, 1998. Service fee income increased
$128,000 due primarily to an increased number of transaction accounts.
Additionally, other income increased $49,000 in 1998 compared to 1997. These
increases were partially offset by decreases of $313,000 in trust income and
$108,000 in income from previously foreclosed assets. Both the increase in
investment center income and the decline in trust income resulted from a
decision made in late 1997 to restructure how investment services were offered
by discontinuing most traditional trust services and redirecting the Company's
efforts into an expanded investment services department provided in conjunction
with LM Financial Partners, Inc. This decision impacted both non-interest income
and non-interest expense.

The Company reported a net gain on sale of securities available for sale of
$52,000 in 1998 compared with $2,000 in 1997. These transactions resulted from
balance sheet management strategies to adjust the estimated average maturity of
the Company's securities portfolio. Gains on sale of other real estate owned
were $29,000 in 1998 and $6,000 in 1997.

NON-INTEREST EXPENSE

A new branch location established in the Maryland Farms area of Brentwood,
Tennessee, expansion of investment services provided in conjunction with LM
Financial Partners, Inc., expansion of "Bank on Call" mobile branching, upgrades
of the Company's computer systems and expenses related to the Company's Year
2000 project contributed to increases in non-interest expenses in 1998. Total
non-interest expense increased 15.9% from $5.2 million in 1997 to $6.1 million
in 1998. Non-interest expense represented 2.9% of average total assets in 1998
compared to 2.7% in 1997. The non-interest expense to assets ratio is an
industry measure of the bank's ability to control its overhead. Control of
non-interest expense is essential to profit maximization; therefore, all
non-interest expense categories have been and will continue to be closely
managed through strategic and financial planning, as well as being monitored by
management through regular measurements. However, management will continue to
implement its strategic plan expanding geographic locations and product lines,
as appropriate, to provide greater future opportunities. Effective management of
expenses while expanding and experiencing solid growth in traditional service
offerings is a focus of the Company's management. During 1998, salaries and
employee benefits increased $684,000, or 25.6%, primarily due to additional
personnel employed to deliver investment services, staffing of the Brentwood
location, expansion of the Company's mobile branch service and addition of
personnel in the technology and operations area, some of whom are actively
involved in the Company's Year 2000 project. Occupancy expense increased
$119,000, or 16.7%, in 1998 compared to 1997 as a result of the establishment of
the Company's Brentwood Office in September, 1998. Other operating expenses
increased $117,000 during 1998 compared to 1997. These increases in non-interest
expense were partially offset by decreases in other non-interest expense
categories. Advertising and marketing expense declined $47,000, or 24.6%, in
1998 compared to 1997 as a result of less utilization of media expense related
to the opening of the Brentwood Office compared to the media expense incurred
with the opening of the Green Hills Office in 1997. Audit, tax and accounting
expense and data processing expense declined $7,000 and $18,000, respectively,
in 1998 compared to 1997 primarily as a result of the Company's decision to
discontinue its trust department. Non-interest expense, other than salaries and
employee benefits, increased $151,000, or 5.9%, during 1998 compared to 1997,
while assets grew $33.3 million.



                                      -16-
<PAGE>   11


During the second quarter of 1998, the Company purchased property in
Hendersonville and has begun construction on a new branch office planned to open
in the late spring of 1999. Other planned expenses relate to the expansion of
the Company's delivery systems and service locations and include additional
mobile branch service employees and equipment, an investment in an internet
banking system and consulting and legal expense related to expansion of
additional lines of business. Other than these planned expenses, management
anticipates only minimal growth in most non-interest expense categories during
1999. During 1998, costs related to Year 2000 were approximately $115,000 and
are projected to be approximately $135,000 in 1999. A more detailed discussion
of Year 2000 issues is presented under the caption, "Nonperforming Assets and
Risk Elements". It should be noted that economic conditions and other factors in
the market could further impact non-interest expense.

INCOME TAXES

During 1998, the Company recorded provision for income taxes of $1.6 million
compared to $1.3 million during 1997. During 1998, reported earnings were
impacted by a franchise tax accrual of $63,000 resulting largely from additional
capital generated by the exercise of the Company's warrants during the fourth
quarter of 1998. The effective tax rate was approximately 38% for 1998 and 39%
for 1997. The Company continues to explore strategies which would lower the
effective tax rate while being consistent with its profits goals.

EARNING ASSETS

Average earning assets increased $15.7 million, or 8.5%, in 1998 from 1997. This
increase was the result of a 16.4% increase in average loans, which was
partially offset by decreases of 4.0% in investment securities, 6.0% in federal
funds sold and 51.1% in due from banks. These changes reflected both the growth
in loans and the subsequent change in the mix of average earning assets which
occurred during 1998 when compared to 1997. During 1998, the mix of average
earning assets reflected loans at 66.7%, investment securities at 29.5%, federal
funds sold at 3.6% and due from banks at .1%. This compares with a mix in 1997
which reflected loans at 62.2%, investment securities at 33.4%, federal funds
sold at 4.2% and due from banks at .2%. The shift in mix during 1998 from
investments to higher yielding loans contributed to higher net interest income
as the percentage of loans to total earning assets increased. The mix of earning
assets is monitored on a continuous basis with adjustments made in other areas
based on the availability of quality loan demand. An analysis of the 16.4%
increase in average total loans outstanding in 1998 compared to 1997 reflects a
11.6% increase in average real estate mortgage and real estate construction
loans and a 35.0% increase in average commercial loans. The loan portfolio table
below shows the classifications of loans by major categories at December 31,
1998 and 1997. Real estate mortgage and construction loans are primarily
commercial as opposed to one to four family residential.

LOAN PORTFOLIO


<TABLE>
<CAPTION>
                                      December 31                      Change from Prior Year
(Dollars In Thousands)      1998        % Total       1997        % Total      Amount        %
------------------------------------------------------------------------------------------------
<S>                       <C>           <C>         <C>           <C>         <C>           <C>
LOAN CATEGORIES
Commercial                $ 51,970       34.0%      $ 38,571       31.4%      $13,399       34.7%
Real Estate/
  Mortgage Loans            79,455       52.1         71,055       57.9         8,400       11.8
Real Estate/
  Construction Loans        14,667        9.6          9,426        7.7         5,241       55.6
Consumer                     6,583        4.3          3,697        3.0         2,886       78.1
------------------------------------------------------------------------------------------------

   Total Loans            $152,675      100.0%      $122,749      100.0%      $29,926       24.4%
================================================================================================
</TABLE>



                                      -17-
<PAGE>   12


The loan portfolio mix continues to reflect the Company's efforts to serve its
target market of small and mid-sized businesses in its community. The condition
of the economy and competitive environment of the Company's market, as well as
management's focus on asset quality, impact the Company's ability to experience
loan growth. Both economic conditions and loan growth remained strong during
1998; however, the market continued to be very competitive as the supply of
available credit often outpaced quality loan demand. At December 31, 1998, loan
demand appeared to be moderately strong; however, international economic
uncertainty and concentration on Year 2000 issues have caused some businesses to
be cautious in their outlook, despite the strengths of the underlying U.S. and
local economies.

The Company has not invested in loans which would be considered highly leveraged
transactions ("HLT") as defined by the Federal Reserve Board and other
regulatory agencies. Loans made by companies for recapitalization or
acquisitions (including acquisitions by management or employees) which result in
a material change in the borrower's financial structure to a highly leveraged
condition are considered HLT loans. The Company has no foreign loans.

The Company's securities are held as available for sale and provide for
liquidity needs while contributing to profitability. During 1998, the Company
continued utilizing a leveraging strategy begun in 1996 which was comprised of
Federal Home Loan Bank secured borrowings used to fund matched investments of
U.S. Government and municipal securities. Such strategies require careful
monitoring and measurement of the interest rate risk, but have the potential for
providing significant contributions to net interest income. See the "Liquidity
and Asset/Liability Management" section. In the fourth quarter of 1998, the
Company made an investment in a factoring company which was consistent with its
strategic plan to invest in other lines of business. The composition of the
securities portfolio reflects an investment strategy of maximizing portfolio
yields commensurate with risk and liquidity considerations. The primary
objectives of the Company's investment strategies are to maintain an appropriate
level of liquidity and to provide a tool to assist in controlling the Company's
interest rate position while, at the same time, producing adequate levels of
interest income. Securities held as available for sale are carried on the
Company's balance sheet at estimated fair value. As a result, the Company
recognized an increase in equity of $340,000 for unrealized gains on securities
held as available for sale, net of tax, at December 31, 1998, which compares
with an increase of $294,000 for unrealized gains on these securities in 1997.
During 1998, gross securities sales were $3,102,000 and paydowns, including
prepayments, were $33,599,000, representing 5.2% and 57.3%, respectively, of the
average total portfolio for the year. Net gains associated with the sale of
securities available for sale during 1998 were $52,000 compared with $2,000 in
1997. Total average investments decreased $2.5 million, or 4.0%, during 1998
compared to 1997, while total securities at year end 1998 were $5.6 million, or
8.5%, greater than year end 1997 as the Company deployed funds generated from
the exercise of warrants which resulted in an increase in equity. The average
yield on investment securities was 6.7% in both 1998 and 1997. The following
table contains the carrying amount of the securities portfolio at the end of
each of the last two years.

SECURITIES AVAILABLE FOR SALE


<TABLE>
<CAPTION>
                                                            December 31,
(In Thousands)                                           1998         1997
--------------------------------------------------------------------------------
<S>                                                     <C>          <C>
   U.S. Treasury securities and
      obligations of U.S. Government agencies           $35,900      $31,426
   Securities of states and political subdivisions        1,309          382
   Collateralized mortgage obligations                   31,721       32,121
   Equity securities                                      2,732        2,130
--------------------------------------------------------------------------------

        Total                                           $71,662      $66,059
================================================================================
</TABLE>



                                      -18-
<PAGE>   13


The maturities and average weighted yields of the Company's investment portfolio
at the end of 1998 are presented in the following table using primarily the
estimated expected life. The average stated maturity of the mortgage backed
securities was 1.6 years, and the estimated life was 1.1 years. At year end
1998, all securities were held as available for sale.

DEBT SECURITIES AVAILABLE FOR SALE MATURITY SCHEDULE


<TABLE>
<CAPTION>
                                               December 31, 1998
------------------------------------------------------------------------------------------
                               Within                   After 1 But          After 5 But
                               1 Year                  Within 5 Years      Within 10 Years
(Dollars In Thousands)         Amount      Yield      Amount     Yield     Amount    Yield
------------------------------------------------------------------------------------------
<S>                           <C>          <C>       <C>         <C>       <C>       <C>
U.S. Treasury
  securities and
  obligations of U.S.
   Government agencies        $14,759      5.7%      $21,141      7.0%      $ --       --%
Securities of states and
  political subdivisions           --       --           386      8.1        923      6.7
------------------------------------------------------------------------------------------

     Total                    $14,759      5.7%      $21,527      7.0%      $923      6.7%
==========================================================================================
</TABLE>


The previous table excludes collateralized mortgage obligations at an estimated
fair value of $31,721,000 and investments in equity securities which have no
stated maturity. Maturities of collateralized mortgage obligations can be
expected to differ from scheduled maturities due to the prepayment or early call
privileges of the issuer. Average federal funds sold remained relatively level
during 1998 compared to 1997. However, at December 31, 1998, the Company had no
federal funds sold compared to $9.4 million in federal funds sold at year end
1997. Federal funds sold represent a short-term investment used primarily for
liquidity purposes in the Company's asset liability management strategy.

DEPOSITS

During 1998, the Company's volume and mix of liabilities shifted somewhat as
average shareholders' equity increased $4.5 million and average other borrowings
declined slightly by $.4 million. The portion of average liabilities and
shareholders' equity represented by deposits, the primary source of funding for
the Company, stood at 79.9%, a slight decrease from the 80.0% during 1997. This
decrease resulted primarily from the Company's additional shareholders' equity
from exercise of warrants. Average deposits increased $14.7 million, or 9.6% in
1998 compared to 1997. At December 31, 1998, total deposits were $162.6 million,
a decline of .9% from the $164.1 million reflected at December 31, 1997. The
slight decline in deposits at year end 1998 compared to 1997 was the result of a
temporary decline in money market accounts combined with a decline in time
certificates of deposit that resulted from a strategic decision to utilize
additional shareholders' equity rather than higher rate certificates of deposit
to fund earning assets. At December 31, 1998, compared to the same period in
1997, non-interest bearing demand deposits increased $5.4 million, or 43.0%, NOW
accounts increased $4.0 million, or 43.4%, while money market accounts declined
$3.8 million, or 5.0%, time certificates less than $100,000 declined $6.5
million, or 19.1%, and time certificates of $100,000 and greater declined $.7
million, or 2.1%. This shift in the mix of deposits reflected the Company's
business development efforts in establishing relationship transaction accounts
and becoming less reliant on higher cost certificates of deposit. With the
addition of the Green Hills Office which opened in 1997 and the Brentwood Office
which opened in the third quarter of 1998, together with the expansion of the
Company's mobile branching service, the Company has had additional opportunities
to expand its commercial and consumer relationships. The shift in the mix of
deposits as well as a general decline in interest rates during 1998 contributed
to a decline of 34 basis points in the average rate paid on interest bearing
liabilities during 1998 compared to 1997.



                                      -19-
<PAGE>   14


The deposit mix at December 31, 1998 reflected the changes that occurred during
the year as well as temporary year-end fluctuations with non-interest bearing
deposits at 11.1%, NOW accounts at 8.2%, money market accounts at 43.8%, time
deposits under $100,000 at 17.1% and time deposits $100,000 or greater at 19.8%.
This compares to a deposit mix at year end 1997 which reflected non-interest
bearing deposits at 7.7%, NOW accounts at 5.7%, money market accounts at 45.7%,
time deposits under $100,000 at 20.9% and time deposits $100,000 or greater at
20.0%. The shift in the mix of the Company's deposit base reflects its branch
expansions which have resulted in additional consumer deposits in NOW accounts
as well as the expansion of its commercial deposit base as reflected by the
increase in non-interest bearing demand deposits. Maturities of time deposits
$100,000 or more issued by the Company at December 31, 1998 are summarized in
the following table.

MATURITIES OF CERTIFICATES OF DEPOSIT OF $100,000 AND OVER

<TABLE>
<CAPTION>
            (In Thousands)
            <S>                                                                     <C>
            Three months or less                                                    $15,157
            Over three through six months                                             8,843
            Over six through twelve months                                            4,612
            Over twelve months                                                        3,573
-------------------------------------------------------------------------------------------
            Total                                                                   $32,185
===========================================================================================
</TABLE>


At year-end 1998, the Company had total borrowings of $22.5 million comprised of
$14.5 million in Federal Home Loan Bank borrowings and $8.0 million in federal
funds purchased. The average volume of these borrowings during 1998 was $12.7
million compared to $13.1 million during 1997 with an average rate paid on
borrowed funds during 1998 of 5.5% compared to 5.7% during 1997. The average
rate paid on average total interest bearing liabilities was 4.9% in 1998
compared with 5.3% in 1997.

The ratio of average loans, net of unearned income, to average total deposits
was 79.90% in 1998, compared to 75.2% in 1997. This higher loan to deposit ratio
reflected the increase in average loans which occurred in 1998. The loan to
deposit ratio at December 31, 1998, was 93.9% compared to 74.8% at year-end
1997. Most financial institutions manage the loan to deposit ratio considering
the capital to asset ratio. The Company's management has considered its capital
ratio in conjunction with its higher loan to deposit ratio.

LIQUIDITY AND ASSET/LIABILITY MANAGEMENT

The Company's asset liability management process actively involves the Board of
Directors and members of senior management. The Asset Liability Committee of the
Board of Directors meets at least quarterly to review strategies and the volume
and mix of assets as well as funding sources. Decisions relative to different
types of securities are based upon the assessment of various economic and
financial factors, including, but not limited to interest rate risk, liquidity,
and capital adequacy. Interest rate sensitivity is a function of the repricing
characteristics of the Company's portfolio of earning assets and interest
bearing liabilities. These repricing characteristics are the timeframes within
which interest bearing assets and liabilities are subject to a change in
interest rate either by replacement, repricing or maturity of the instrument.
Interest rate sensitivity management focuses on the maturity structure of assets
and liabilities and their repricing characteristics during periods of change in
market interest rates. Effective interest rate risk management seeks to ensure
that both assets and liabilities respond to changes in interest rate movement
similarly to minimize the effect on net interest income by these fluctuations.
Management utilizes computer interest rate simulation models and analysis to
determine the Company's interest rate sensitivity. Management also evaluates the
condition of the economy, the pattern of market interest rates and other
economic data to determine the appropriate mix and repricing characteristics of
assets and liabilities.



                                      -20-
<PAGE>   15


In addition to ongoing monitoring of interest rate sensitivity, the Company may
enter into various interest rate contracts to augment the management of the
Company's interest sensitivity. These contracts may be used to supplement the
Company's objectives relating to its interest sensitivity position. The interest
rate risk factor in these contracts is considered in the overall risk management
strategy of the Company. The Company also utilizes certain leveraging strategies
within risk tolerance guidelines established by its Board of Directors for the
purpose of increasing net income. Such strategies involve the utilization of
borrowings to fund investment securities with similar maturities or repricing
characteristics which result in an acceptable interest rate spread. During 1998,
these strategies contributed $17,000 to the Company's net income. Leveraging
strategies are carefully monitored by the Company's Board of Directors who have
established parameters for matching investment purchases with Federal Home Loan
Bank borrowings. On a monthly basis, a matched investment income report is
reviewed by the Company's Board of Directors in an effort to manage risk.
Additionally, the Asset Liability Committee of the Company's Board of Directors
has established a maximum level of borrowings/investments of $25 million and has
implemented guidelines which require preapproval of each phase of the strategy
prior to implementation. While such strategies contribute to increases in net
interest income, they also have the effect of lowering the net interest margin
and increasing the Company's exposure to interest rate risk. Managing and
regularly monitoring interest rate risk associated with the leveraging strategy
are the responsibility of both management and the Company's Board of Directors.
At December 31, 1998, the Company had borrowings totaling $22.5 million compared
to $14.5 million at December 31, 1997. Approximately $4.5 million of the
borrowings reflected at December 31, 1998, were used to fund investment
securities.

The following interest rate gap table reflects the Company's rate sensitivity
position at December 31, 1998. The carrying amount of interest rate sensitive
assets and liabilities is presented in the periods in which they next reprice to
market rates or mature and is summed to show the interest rate sensitivity gap.
To reflect anticipated prepayments, certain investments are included in the
table based on estimated rather than contractual maturity dates.

<TABLE>
<CAPTION>
                                           Expected Repricing or Maturity Date
                                   Within            One            Two         After
                                    One             to Two        to Five       Five
                                    Year             Years         Years        Years          Total
(Dollars In Thousands)                                             1998
-------------------------------------------------------------------------------------------------------
<S>                                <C>              <C>           <C>           <C>            <C>
Assets
   Debt and equity securities      $ 35,398         $22,637       $12,704       $   923        $ 71,662
   Average rate                        5.85%           6.87%         6.52%         6.70%           6.30%
   Net loans                       $112,965         $ 8,854       $19,333       $11,523        $152,675
   Average rate                        8.28%           8.98%         8.56%         8.42%           8.37%
   Other                           $    954         $    --       $    --       $    --        $    954
   Average rate                        4.76%             --            --            --            4.76%
-------------------------------------------------------------------------------------------------------

Total interest-earning assets      $149,317         $31,491       $32,037       $12,446        $225,291

Liabilities
   Deposits                        $135,489         $ 6,383       $ 2,698       $     3        $144,573
   Average rate                        3.93%           5.83%         5.87%         4.95%           4.41%
   Federal Home Loan
   Bank and other borrowings       $ 17,500         $ 5,000       $    --       $    --        $ 22,500
   Average rate                        5.21%           4.45%           --            --            5.05%
-------------------------------------------------------------------------------------------------------
Total interest-bearing
  liabilities                      $152,989        $ 11,383       $ 2,698       $     3        $167,073
-------------------------------------------------------------------------------------------------------

Interest rate sensitivity gap      $ (3,672)        $20,108       $29,339       $12,443        $ 58,218
=======================================================================================================

Cumulative interest rate
  sensitivity gap                  $ (3,672)        $16,436       $45,775       $58,218
=======================================================================================================
</TABLE>



                                      -21-
<PAGE>   16


Liquidity is the ability of the financial institution to meet the needs of its
customers and creditors. High levels of liquidity reduce earnings, as liquidity
is normally obtained at a net interest cost as a result of generally lower
yields on short term, interest earning assets and the higher interest expense
usually associated with the extension of deposit maturities. The Company's
principal sources of asset liquidity are marketable securities available for
sale and federal funds sold, as well as maturity of securities. The estimated
average maturity of securities was 7.0 years at December 31, 1998 compared to
5.1 years at December 31, 1997. Securities available for sale were $71.7 million
at December 31, 1998, compared to $66.1 million at December 31, 1997. The
Company had federal funds purchased of $8.0 million at December 31, 1998
compared with federal funds sold of $9.4 million at December 31, 1997. Core
deposits, a relatively stable funding base, represented 80.2% of total deposits
at December 31, 1998, and 80.0% of total deposits at year-end 1997. Core
deposits are defined as total deposits, less time certificates of deposit
$100,000 or greater. Liquidity is strengthened and reinforced by maintaining a
relatively stable funding base which is achieved by providing relationship
banking, extending contractual maturities of liabilities and reducing reliance
on volatile short term purchased funds. Maintaining acceptable levels of
liquidity has been an ongoing consideration of the Company's Asset/Liability
Committee and is regularly monitored and adjusted, as appropriate. It is
recognized that maintaining an acceptable level of liquidity becomes even more
important during periods of economic uncertainty and volatile financial markets.

Due to the commercial nature of the Company's target market, liabilities and
loans are evaluated relative to industry concentration and volatility. At
December 31, 1998, approximately 22.2% of deposits were related to the
construction industry, 3.6% to real estate development/investment industries,
while 4.0% were related to health care, 9.4% state and local government and 2.7%
were related to the automotive and transportation industry. These areas are the
Company's largest deposit concentrations and represent significant industries
within the Nashville area. These deposits are primarily reflected in the
Company's demand deposits and interest bearing money market accounts and are
deposits of relationship commercial customers which, by their nature, are
concentrated in a fewer number of customer relationships than would be the case
for consumer deposit funding sources. At December 31, 1998 and 1997, all
investment securities were classified as available for sale.

MARKET RISK

Market risk is the risk of loss from adverse changes in market prices and rates.
The Company's market risk arises primarily from interest rate risk inherent in
its lending and deposit taking activities. To that end, management actively
monitors and manages its interest rate risk exposure.

The Company's profitability is affected by fluctuations in interest rates. A
sudden and substantial movement in interest rates may adversely impact the
Company's earnings to the extent that the interest rates borne by assets and
liabilities do not change at the same speed, to the same extent, or on the same
basis. The Company monitors the impact of changes in interest rates on its net
interest income using several tools. One measure of the Company's exposure to
changes in interest rates between assets and liabilities is shown in the
Company's gap table under the "Liquidity and Asset/Liability Management"
caption.

At least quarterly, the Asset/Liability Committee (ALCO) of the Board of
Directors reviews interest rate risk considering results compared to policy,
current rate and economic outlooks, loan and deposit demand levels, pricing and
maturity of assets and liabilities, impact on net interest income under varying
rate scenarios, regulatory developments, comparison of modified duration of both
assets and liabilities as well as any appropriate strategies to counteract
adverse interest rate projections. The Company's imbalance between the duration
of assets and liabilities is limited to under one year and generally should not
exceed one-half year.



                                      -22-
<PAGE>   17


Management recommends the appropriate levels of interest rate risk to be assumed
within limits approved by the ALCO and the Board of Directors as to the maximum
fluctuations acceptable in the market value of equity and in earnings assuming
sudden rate movement (rising or falling) up to 200 basis points. The Company's
policy establishes the maximum change in annual pre-tax interest income with a
200 basis point change in rates to 10% while establishing the maximum change
allowable in pre-tax market value of capital to 12% in the same assumed rate
environment.

The Company's primary objective in managing interest rate risk is to minimize
the adverse impact of changes in interest rates on the Company's net interest
income and capital, while structuring the Company's asset/liability structure to
obtain the maximum yield-cost spread. The Company relies primarily on its asset
liability structure to control interest rate risk.

Based on December 31, 1998 financial data, a 200 basis point change in rates
would produce net interest income variations of a .5% increase assuming falling
rates and a 2.7% decrease assuming rising rates. Additionally, the 200 basis
point rate shock would produce changes in the market value of equity of a
decrease of 6.4% assuming rising rates and a 6.1% increase assuming falling
rates.

The Company continually evaluates interest rate risk management opportunities,
including the use of derivative financial instruments. Management believes that
hedging instruments currently available are not cost effective to the Company,
and therefore, has focused its efforts on increasing the Company's yield-cost
spread through growth opportunities.



                                      -23-
<PAGE>   18


The following table shows the Company's financial instruments that are sensitive
to change in interest rates, categorized by expected maturity, and the
instruments fair value at December 31, 1998. Market risk sensitive instruments
are generally defined as derivatives and other financial instruments both on
balance sheet and off balance sheet.

<TABLE>
<CAPTION>
                              Average                         Expected Maturity/Principal Repayment
                             Interest   ---------------------------------------------------------------------------------
                               Rate                                                          There-     Total       Fair
(DOLLARS IN MILLIONS)                    1999        2000      2001      2002      2003      After     Balance      Value
-------------------------------------------------------------------------------------------------------------------------
<S>                          <C>        <C>         <C>        <C>       <C>       <C>       <C>       <C>          <C>
Interest-Sensitive
Assets:
  Fed funds sold and
   other short-term
   investments                 4.76%    $  1.0      $  --      $ --      $ --      $ --      $  --      $  1.0      $  1.0
  Loans Receivable (1)         8.37      112.5        8.9       6.9       7.6       4.9       11.9       152.7       153.1
  Investment Securities        6.30       35.3       22.6       8.1       2.0       2.7         .4        71.1        71.7

Interest-Sensitive
Liabilities:
 Deposits                      3.93      135.5        6.4       1.3        .8        .6         --       144.6       144.9
 FHLB and other
   borrowings                  5.05       17.5        5.0        --        --        --         --        22.5        22.7
Interest-Sensitive
 Off balance sheet
  Items: (2)
 Commitments to extend
  credit                       8.31                                                                       58.2           *
 Unused lines of credit       11.76                                                                        4.8           *
==========================================================================================================================
</TABLE>

(1) Loans are not reduced for the allowance for loan losses.

(2) Total balance equals the notional amount of off-balance sheet items and
    interest rates are the weighted average interest rates of the underlying
    loans or commitments.

* The estimated fair value of these items was not significant.

Expected maturities are contractual maturities adjusted for prepayments of
principal. The Company uses certain assumptions to estimate fair values and
expected maturities. For assets, expected maturities are based upon contractual
maturity, projected repayments, and estimated prepayments of principal. The
actual maturities of these instruments could vary substantially if future
prepayments differ from the Company's historical experience.



                                      -24-
<PAGE>   19


NONPERFORMING ASSETS AND RISK ELEMENTS

Nonperforming assets, which include nonaccrual loans, restructured loans, and
other real estate owned, were $460,000 at December 31, 1998, compared with
$1,227,000 at December 31, 1997. The following table represents the composition
of nonperforming assets at December 31, 1998 and 1997.

NONPERFORMING ASSETS

<TABLE>
<CAPTION>
                                                   December 31
(Dollars In Thousands)                          1998         1997
-----------------------------------------------------------------
<S>                                             <C>        <C>
NONPERFORMING ASSETS:
  Nonaccrual loans                              $408       $1,094
  Restructured loans                              --           --
  Other real estate owned                         52          133
-----------------------------------------------------------------

     Total                                      $460       $1,227
=================================================================

Nonperforming assets as a percent of
  total loans plus other real estate owned       0.3%         1.0%
=================================================================
</TABLE>

There were no loans ninety days or more past due at December 31, 1998 and 1997
that were not included in the nonaccrual category. During 1998, $925,000 of
loans were transferred from earnings status to nonaccrual status and there were
no advances on nonaccrual loans. This compares to $976,000 of loans transferred
from earnings status to nonaccrual status in 1997. In 1998 and 1997 there were
$1,611,000 and $461,000, respectively of loans transferred from nonaccrual
status primarily due to the repayment of principal. In 1998, there was one loan
removed from nonaccrual status and placed in other real estate owned reflecting
a balance of $52,000 at December 31, 1998. The Company had $133,000 in other
real estate owned at December 31, 1997. During 1998, loans totaling $84,000 were
charged-off with recoveries reported of $474,000 compared to charge-offs of
$169,000 and recoveries of $319,000 in 1997. These charge-offs and recoveries
resulted in net recoveries during 1998 of $390,000 compared to net recoveries in
1997 of $150,000. The Company evaluates the credit risk of each customer on an
individual and on-going basis and, where deemed appropriate, obtains collateral.
Collateral values are monitored to ensure that they are maintained at
appropriate levels. The largest component of the Company's credit risk relates
to the loan portfolio. During 1998, the Company continued its emphasis on
underwriting standards and loan review procedures. As discussed in the section,
"Provision for Loan Losses", asset quality and loan charge-off and recovery
experience impact the level of the allowance for loan losses maintained.

At December 31, 1998 and 1997, other potential problem loans totaled $256,000
and $177,000, respectively. Other potential problem loans consist of loans that
are currently not considered nonperforming, but where information about possible
credit problems has caused the Company to have serious doubts as to the ability
of the borrower to fully comply with present repayment terms. Depending on
economic changes and future events, these loans and others, which may not be
presently identified, could become future nonperforming assets. The composition
of nonperforming assets at December 31, 1998 was 11.3% in other real estate
owned and 88.7% in nonaccrual loans which compares to 10.8% in other real estate
owned and 89.2% in nonaccrual loans at December 31, 1997. The largest nonaccrual
loan at December 31, 1998 was $242,000.

At December 31, 1998, the Company's allowance for loan losses was $3.6 million,
or 2.4%, of total loans compared with $3.1 million, or 2.5%, at December 31,
1997. The level of the allowance for loan losses is monitored regularly by
management and the Company's Board of Directors.



                                      -25-
<PAGE>   20


During 1998, management and the Board of Directors continued its emphasis on the
Year 2000 implementing a comprehensive project plan, adopting a test plan and
establishing contingency plans, where appropriate. Year 2000 (Y2K) represents an
issue which refers to the process of converting computer programs to recognize
more than two digits identifying a year in any date field. The Company
recognizes the technology and financial risks to both the Company and its
customers as the new millennium approaches and is taking appropriate steps as
outlined in the Company's "Year 2000 Readiness Disclosure Statement" to combat
these risks. The Company completed assessments of all systems and completed
remediation and/or testing of all internal systems by December 31, 1998. The
software system utilized for the Company's primary core applications processing
is fully warranted by a financially strong, publicly traded company that
supplies this software to over 200 financial institutions nationwide. The
Company has no internally developed systems. Additionally, the Company has
actively participated in proxy testing with external vendors upon whom the
Company is reliant and has carefully reviewed the results of all tests to ensure
these systems are Y2K compliant. Testing or reviewing test scripts with other
external vendors on whom the Company is less dependent but with whom there is
some interaction, will continue through the first two quarters of 1999 with
completion planned prior to June 30, 1999. The costs related to this project
were projected and totaled approximately $115,000 in 1998 and are not expected
to exceed $135,000 in 1999. In addition to testing, renovating and/or replacing
systems, as appropriate, the Company is cognizant of the potential impact of Y2K
on its borrowing customers and large depositors and has, therefore, established
a system for monitoring the Y2K compliance of these customers. The Company has
also assessed its investment portfolio relative to Y2K risk exposure.
Additionally, the Company's Y2K Task Force has established a date of June 30,
1999 on which no further changes will be made to technology systems except as
necessary due to changes in regulatory requirements. Both a contingency and a
liquidity plan have been prepared and will be implemented, as appropriate,
during 1999 to ensure the Company is prepared to serve its customers. In an
effort to communicate with customers, the Company has published and distributed
a "Year 2000 Readiness Disclosure Statement" in addition to a series of
newsletter articles. Y2K credit risk continues to be assessed on all loans above
a predetermined amount, Y2K language is being incorporated into contracts and
loan agreements, and the Company continues to educate all officers to be attuned
to the potential risks associated with the Year 2000. During 1998, the Company
sponsored a seminar to increase customer awareness of Y2K risks and solutions.
Management and the Board of Directors remain committed to ensuring that the
Company's customers and shareholders will not be impacted by the Y2K issue.

CAPITAL STRENGTH

The Company experienced a material change its capital structure in 1998 as 2.0
million warrants, each representing the right to acquire a common share at a
price of $12.50, were exercised resulting in the addition of $25.0 million in
new equity capital. Since all warrants had an expiration date of December 31,
1998, there are no remaining warrants outstanding. Management and the Board of
Directors had previously recognized the potential for additional capital and had
reviewed both long-term and short-term strategies considering the appropriate
deployment of additional capital. The majority of the additional capital was
received during the last week of 1998; therefore, management implemented its
short-term investment strategy and together with the Board of Directors is now
actively evaluating appropriate longer-term business opportunities.

SHAREHOLDERS EQUITY

Shareholders' equity (excluding other comprehensive income) at December 31,
1998, was $50.8 million, or 21.3% of total assets, which compares with $23.8
million, or 11.6% of total assets at December 31, 1997. This calculation, when
considered after the effect of the Company's adoption of Statement of Financial
Accounting Standards (SFAS) No. 115, was $51.2 million, or 21.5%, at December
31, 1998, which compares with $24.1 million, or 11.7%, of total assets at
December 31, 1997. The increase in total equity during 1998 primarily resulted
from the proceeds ($25.0 million) from the issuance of common stock as warrants
were exercised; however, 1998 earnings net of dividends paid as well as a slight
increase ($46,000) in the unrealized gain on securities available for sale at
year end 1998 compared with year end 1997 further contributed to the increase in
total equity. Certain capital statistics are shown in the following chart:



                                      -26-
<PAGE>   21


CAPITAL STATISTICS

<TABLE>
<CAPTION>
                                                      December 31
(Dollars In Thousands)                            1998           1997
-----------------------------------------------------------------------
<S>                                             <C>            <C>
Total assets                                    $238,185       $204,887
-----------------------------------------------------------------------

Total shareholders' equity                        51,171         24,052
-----------------------------------------------------------------------

Total shareholders' equity to total assets          21.5%          11.7%
-----------------------------------------------------------------------
</TABLE>

Management and the Board of Directors recognized in 1998 the opportunities that
would be provided by an influx of capital. It is further recognized that the
increased number of shares outstanding (1,996,807) in 1999 will reduce basic
earnings per share on a comparative basis until the Company has the opportunity
to more effectively deploy the additional capital.

While, in the past, the Company's capital ratios have exceeded all regulatory
requirements, currently its ratios indicate a significant amount of excess
capital based on industry standards and Federal Deposit Insurance Corporation
Improvement Act ("FDICIA") minimum ratios, resulting from the addition of $25.0
million in new capital, primarily in the last week of 1998. The Company reported
dividend payments in 1998 of $569,000 which compares with dividend payments in
1997 of $441,000. Each quarterly dividend payment made in 1998 was made at $.06
per share. The Company announced an increase in the quarterly dividend payment
per share of $.01 to $.07 a share during the first quarter of 1999. It should be
noted that this increase in the dividend payment amount per share combined with
the approximately 2.0 million additional outstanding shares in 1999 will
significantly increase the total amount of dividend payments.

IMPACT OF NEW ACCOUNTING STANDARDS

In June 1998, the Financial Accounting Standards Board issued SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities". SFAS No. 133
establishes accounting and reporting standards for derivative instruments,
including certain derivative instruments embedded in other contracts and for
hedging activities. SFAS No. 133 requires that an entity recognize all
derivatives as either assets or liabilities in the balance sheet and measure
those instruments at fair value. Gains or losses resulting from changes in the
valuation of derivatives will be accounted for based upon the use of the
derivative and whether it qualifies for hedge accounting. SFAS No. 133 could
increase volatility in earnings and other comprehensive income. This statement
is effective for all fiscal quarters of fiscal years beginning after June 15,
1999. Initial application of this statement should be as of the beginning of an
entity's fiscal quarter; on that date, hedging relationships must be
redesignated and documented pursuant to the provisions of this statement.
Earlier application of this statement is encouraged, but it is permitted only as
of the beginning of any fiscal quarter that begins after issuance of this
statement and should not be applied retroactively to financial statements of
prior periods. The Company has not yet determined when it will adopt SFAS No.
133. The Company does not extensively utilize derivatives, thus the impact of
SFAS No. 133 is not expected to be material.



                                      -27-
<PAGE>   22


MANAGEMENT'S DISCUSSION AND ANALYSIS 1997 VS. 1996

The narrative which follows is management's discussion and analysis of 1997
results of operations of the company compared to 1996.

Net income for 1997 was $2.1 million, or $.93 basic earnings per share, compared
with net income of $2.5 million, or $1.16 per share in 1996. Diluted earnings
per share were $.89 and $1.15 for the years ended December 31, 1997 and 1996,
respectively. The decline in earnings was the result of having fully utilized
all federal and state net operating loss carry forwards in prior periods, thus
the Company became fully taxable in 1997. Income before taxes increased
$674,000, or 24.8%, to $3.4 million in 1997 compared to $2.7 million in 1996.
Return on average shareholder's equity (exclusive of SFAS No. 115 adjustments)
was 9.05% in 1997 compared to 12.18% in 1996, while return on average assets for
1997 and 1996 were 1.08% and 1.61%, respectively. During 1997, the Company
expanded service locations and product lines in accordance with its long-term
strategic plan as it continued its focus on asset quality. Income tax expense of
$1.3 million was recorded during 1997 compared to only $168,000 in 1996, a
period in which the Company continued to benefit from the use of net operating
loss carry forwards. Both federal and state net operating loss carry forwards
were fully utilized resulting in the increased income tax expense for 1997. The
maintenance of an adequate level for the allowance for loan losses was reflected
by a provision for loan losses of $100,000 being recorded in 1997, a period in
which net recoveries were $150,000. There was no provision for loan loss expense
recorded in 1996, a period in which net charge-offs were $156,000.

Total assets were $204.9 million at December 31, 1997, compared to $166.7
million at December 31, 1996 representing an increase of 23%. Loans, net of
unearned income, increased $14.9 million, or 13.8%, at year end 1997 compared to
the same period in 1996. Deposits increased $30.8 million, or 23.1% from $133.3
million at year end 1996 to $164.1 million at year-end 1997. This significant
increase in total deposits resulted from the successful opening of the Company's
Green Hills Office in early 1997, as well as other business development efforts.
The loan to deposit ratio reflected the increase in total deposits which
occurred during 1997 with this ratio being 74.8% at December 31, 1997 compared
to 81.0% at year-end 1996.

NET INTEREST INCOME

Net interest income for 1997 increased 13.2% from 1996. Total interest income
increased $2.4 million, or 18.3%, in 1997 as compared to 1996, while total
interest expense increased $1.5 million, or 23.4%, as compared to 1996. The
increase in total interest income was attributable to a 19.4% increase in
average earning assets comprised primarily of increases of $16.4 million in
average investments and $11.9 million in average loans outstanding. Average
interest bearing liabilities increased $26.7 million, or 21.4%, in 1997,
compared to 1996. This increase in interest bearing liabilities resulted
primarily from the opening of the Company's Green Hills Office and focused
business development efforts. In addition to the increase in the volume of
deposit accounts, Federal Home Loan Bank and other borrowings increased $10.4
million as the Company continued to utilize a leveraging strategy begun in the
third quarter of 1996 which consisted of matching Federal Home Loan Bank
borrowings to fund the purchase of additional investment securities. The average
rate paid on interest bearing liabilities increased 9 basis points in 1997
compared to 1996. Total interest expense increased $1.5 million, or 23.4%, in
1997 compared to 1996 due primarily to an increase of 21.4% in average interest
bearing liabilities as well as the increase of 9 basis points in the average
rate paid on interest bearing liabilities during 1997 compared to 1996. The
opening of the Company's Green Hills Office and related promotional activities
contributed to the large increase in interest bearing liabilities as well as to
the increase in the average rate paid on these liabilities during 1997 compared
to 1996.



                                      -28-
<PAGE>   23


The Company's net interest margin decreased by 22 basis points to 3.96% in 1997,
primarily as a result of an increase in deposit rates associated with
introductory deposit specials offered with the opening of the Green Hills Office
and the utilization of planned investment leveraging strategies. The net
interest margin was further impacted by a lower loan to deposit ratio and a
shift in the mix of earning assets from higher yielding loans to investment
securities. The interest rate spread declined from 3.19% in 1996 to 3.02% in
1997. The increased level of earning assets combined with the shift in the mix
of earning assets and interest bearing liabilities resulted in a higher level of
net interest income. The positive impact of increased levels of earning assets
was somewhat offset by growth in interest bearing liabilities and an increase in
the average rate paid on those liabilities as well as a decline in the average
rate earned on earning assets during 1997 compared to 1996.

PROVISION FOR LOAN LOSSES

In 1997, the Company recorded $100,000 in expense for loan losses, compared with
no provision expense in 1996. This provision for loan losses was deemed
appropriate due to the growth in the loan portfolio and an increase in
nonperforming assets. Net recoveries were $150,000 in 1997 compared to net
charge-offs of $156,000 in 1996. The allowance for loan losses was 2.5% of loans
at December 31, 1997, compared to 2.7% of loans at the same time in 1996. This
decline in percentage resulted from growth in the loan portfolio of 13.8%. Net
recoveries of $150,000 in 1997 resulted from charge-offs of $169,000 and
recoveries of $319,000 reflecting continued collection efforts on loans charged
off in prior periods. In 1996, net charge-offs of $156,000 resulted from
$697,000 in loan charge-offs and $541,000 in recoveries. The level of the
allowance and the amount of the provision are determined on a quarter by quarter
basis and, given the inherent uncertainties involved in the estimation process,
no assurance can be given as to the amount of the provision or the level of the
allowance at any future date.

NON-INTEREST INCOME

Total non-interest income was $1.4 million in 1997, reflecting an increase of
53.3% in comparison with $927,000 reported in 1996. Non-interest income, less
non-recurring income (gains/losses on sale of securities and other real estate),
increased $495,000, or 53.9% from 1996. Service fee income increased $228,000
due to an increased number of customers and pricing changes reflected in service
charges and NSF and overdraft charges. Trust income increased $138,000 while the
Company's arrangement with LM Financial Partners, Inc. to offer certain
investment services resulted in an increase of $35,000 in income from investment
services. It was announced in late 1997 that the Company planned to restructure
how investment services were offered by discontinuing most traditional Trust
Services and redirecting its efforts to an expanded Investment Services
Department provided in conjunction with LM Financial Partners, Inc. This change
in strategy would impact both non-interest income and non-interest expense.
Other income increased $116,000 during 1997 compared to 1996. These increases in
non-interest income were partially offset by a decline in income from foreclosed
assets of $22,000 in 1997 compared to 1996.

NON-INTEREST EXPENSE

Total non-interest expense increased to $5.2 million in 1997 from $4.7 million
in 1996. Non-interest expense represented 2.7% of average total assets in 1997
compared to 2.9% in 1996. During 1997, salaries and employee benefits increased
$236,000, or 9.7%, primarily due to additional personnel employed at the Green
Hills location and in the Company's "Bank-on-Call" mobile branch service.
Occupancy expense increased $149,000, or 26.5%, in 1997 compared to 1996 as a
result of the establishment of the Company's Green Hills Office in January,
1997. Marketing and advertising expense increased $61,000, or 46.9%, in 1997
from the prior year primarily due to expenses related to advertising and
promoting the Company's new branch. FDIC insurance expense increased $13,000 in
1997 compared to the prior year primarily as a result of the growth in deposits
which occurred during 1997. These increases in non-interest expense were
partially offset by decreases in legal expense of $15,000, data processing
expense of $4,000 and in audit, tax and accounting expense of $2,000.
Non-interest expense other than salaries and employee benefits, increased
$335,000 during 1997 compared to 1996, while assets grew $38.2 million.



                                      -29-
<PAGE>   24


INCOME TAXES

During 1997, the Company recorded provision for income taxes of $1.3 million,
compared to $168,000 during the same period in 1996. During 1996, reported
earnings benefited from tax loss carry forwards which were fully utilized during
that year. As a result of having fully utilized these net operating loss carry
forwards, the 1997 effective tax rate more closely approximated the applicable
statutory income tax rate.

CAPITAL STRENGTH

Total shareholders' equity (excluding other comprehensive income) at December
31, 1997 was $23.8 million, or 11.6% of total assets, which compares with $22.0
million, or 13.2% of total assets at December 31, 1996. The increase in total
equity resulted primarily from 1997 earnings net of dividends paid.



                                      -30-
<PAGE>   25


                           CONSOLIDATED BALANCE SHEETS


<TABLE>
<CAPTION>
                                                               December 31
(Dollars In Thousands)                                     1998            1997
---------------------------------------------------------------------------------
<S>                                                      <C>             <C>
ASSETS
   Cash and due from banks                               $ 13,243        $  7,191
   Federal funds sold                                          --           9,400
   Securities:
      Available for sale (amortized cost of $71,113
      and $65,585, respectively)                           71,662          66,059
   Loans (net of unearned income of $295 and $297,
      respectively):
        Commercial                                         51,970          38,571
        Real estate - mortgage loans                       79,455          71,055
        Real estate - construction loans                   14,667           9,426
        Consumer                                            6,583           3,697
---------------------------------------------------------------------------------
          Loans, net of unearned income                   152,675         122,749
        Less allowance for loan losses                     (3,646)         (3,128)
---------------------------------------------------------------------------------
           Total net loans                                149,029         119,621
---------------------------------------------------------------------------------
   Premises and equipment, net                              2,726             977
   Accrued interest and other assets                        1,525           1,639
---------------------------------------------------------------------------------

Total Assets                                             $238,185        $204,887
=================================================================================


LIABILITIES AND SHAREHOLDERS' EQUITY

LIABILITIES
   Non-interest bearing demand deposits                  $ 17,980        $ 12,570
   Interest-bearing deposits
      NOW accounts                                         13,368           9,319
      Money market accounts                                71,263          75,043
      Time certificates less than $100,000                 27,757          34,293
      Time certificates of $100,000 and greater            32,185          32,874
---------------------------------------------------------------------------------
        Total Deposits                                    162,553         164,099
---------------------------------------------------------------------------------

   Federal Home Loan Bank borrowings                       14,500          14,500
   Federal funds purchased                                  8,000              --
   Accounts payable and accrued liabilities                 1,961           2,236
---------------------------------------------------------------------------------
        Total Liabilities                                 187,014         180,835
---------------------------------------------------------------------------------

   Commitments and contingencies (Notes E, H, I, L)

SHAREHOLDERS' EQUITY:
   Common stock, $6 par value; authorized
      50,000,000 shares; issued and outstanding
      4,216,531 in 1998 and 2,212,420 in 1997              25,299          13,275
   Additional paid-in capital                              19,773           6,736
   Retained earnings                                        5,759           3,747
   Accumulated other comprehensive income,
      net of taxes                                            340             294
---------------------------------------------------------------------------------
        Total Shareholders' Equity                         51,171          24,052
---------------------------------------------------------------------------------

Total Liabilities and Shareholders' Equity               $238,185        $204,887
=================================================================================
</TABLE>


          See accompanying notes to consolidated financial statements.



                                      -31-
<PAGE>   26


                        CONSOLIDATED STATEMENTS OF INCOME


<TABLE>
<CAPTION>
                                                         Year Ended December 31
(In Thousands, Except Per Share Data)                1998         1997          1996
--------------------------------------------------------------------------------------
<S>                                                 <C>          <C>          <C>
INTEREST INCOME:
   Interest and fees on loans                       $12,391      $10,724      $  9,569
   Interest on federal funds sold                       374          398           314
   Interest on balances with banks                       10           19            --
   Interest on securities:
      U.S. Treasury securities                           54          151           365
      Other U.S. government agency obligations        3,557        3,825         2,583
      States and political subdivisions
        - nontaxable                                     57           20             5
      Other securities                                  148          123            63
--------------------------------------------------------------------------------------
              Total interest income                  16,591       15,260        12,899
--------------------------------------------------------------------------------------
INTEREST EXPENSE:
   Interest-bearing demand deposits                   3,830        3,458         2,953
   Time deposits less than $100,000                   1,809        2,061         1,782
   Time deposits $100,000 and over                    1,692        1,693         1,563
   Federal funds purchased                               29           26             8
   Federal Home Loan Bank borrowings                    675          718           140
--------------------------------------------------------------------------------------
              Total interest expense                  8,035        7,956         6,446
--------------------------------------------------------------------------------------
NET INTEREST INCOME                                   8,556        7,304         6,453
Provision for loan losses                               128          100            --
--------------------------------------------------------------------------------------
Net interest income after provision
   for loan losses                                    8,428        7,204         6,453
NON-INTEREST INCOME:
   Service fee income                                   549          421           193
   Trust income                                         224          537           399
   Investment Center income                             662          107            72
   Gain (loss) on sale of
      securities, net                                    52            2            (2)
  Income from foreclosed assets                          --          108           130
   Gain on sale of other real estate owned               29            6            11
   Other                                                289          240           124
--------------------------------------------------------------------------------------
              Total non-interest income               1,805        1,421           927
--------------------------------------------------------------------------------------
NON-INTEREST EXPENSE:
   Salaries and employee benefits                     3,357        2,673         2,437
   Occupancy expense                                    830          711           562
  Legal expense                                          36           45            60
  FDIC insurance                                         15           19             6
  Audit, tax and accounting                             196          203           205
   Advertising expense                                  144          191           130
   Data processing expense                              187          205           209
   Other operating expenses                           1,306        1,189         1,056
--------------------------------------------------------------------------------------
              Total non-interest expense              6,071        5,236         4,665
--------------------------------------------------------------------------------------

Income before income taxes                            4,162        3,389         2,715
Income tax expense                                    1,581        1,331           168
--------------------------------------------------------------------------------------

NET INCOME                                          $ 2,581      $ 2,058      $  2,547
======================================================================================


Net income per share
   Basic                                            $  1.08      $   .93      $   1.16
   Diluted                                              .78          .89          1.15
======================================================================================

Weighted average common shares
   outstanding
   Basic                                              2,394        2,205         2,199
   Diluted                                            3,321        2,324         2,223
======================================================================================
</TABLE>


          See accompanying notes to consolidated financial statements.



                                      -32-
<PAGE>   27


    CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY AND COMPREHENSIVE INCOME


<TABLE>
<CAPTION>
                                                                       Accumulated
                                                                          Other
                                            Additional     Retained   Comprehensive
                                Common       Paid-In       Earnings    Income, Net
                                 Stock       Capital       (Deficit)    Of Tax        Total

(Dollars In Thousands, Except Per Share Amounts)
--------------------------------------------------------------------------------------------
<S>                             <C>         <C>            <C>        <C>            <C>
BALANCE, JANUARY 1, 1996        $13,149      $ 8,500       $(1,916)      $ 279       $20,012
Comprehensive Income:
  Net Income                         --           --         2,547          --
  Other comprehensive
    loss                             --           --            --        (215)
  Total Comprehensive
    Income                           --           --            --          --         2,332
Issuance of Common
  Stock (10,973 shares)              66           27            --          --            93
Transfers to comply
  with state statute,
  Net                                --       (1,851)        1,851          --            --
Cash dividends - $.16
  per share                          --           --          (352)         --          (352)
--------------------------------------------------------------------------------------------
BALANCE, DECEMBER 31, 1996       13,215        6,676         2,130          64        22,085
Comprehensive Income:
  Net Income                         --           --         2,058          --
  Other comprehensive
    income                           --           --            --         230
  Total Comprehensive
    Income                           --           --            --          --         2,288
Issuance of Common
  Stock (9,947 shares)               60           60            --          --           120
Cash dividends - $.20
  per share                          --           --          (441)         --          (441)
--------------------------------------------------------------------------------------------
BALANCE, December 31, 1997       13,275        6,736         3,747         294        24,052
Comprehensive Income:
  Net Income                         --           --         2,581          --
  Other comprehensive
    income                           --           --            --          46
  Total Comprehensive
    Income                           --           --            --          --         2,627
Issuance of common
  stock (2,004,111
  shares)                        12,024       13,037            --          --        25,061
Cash dividends -
  $.24 per share                     --           --          (569)         --          (569)
--------------------------------------------------------------------------------------------
BALANCE, DECEMBER 31, 1998      $25,299      $19,773       $ 5,759       $ 340       $51,171
============================================================================================
</TABLE>


          See accompanying notes to consolidated financial statements.


                                      -33-
<PAGE>   28


                      CONSOLIDATED STATEMENTS OF CASH FLOWS

<TABLE>
<CAPTION>
                                                       Year Ended December 31
(In Thousands)                                   1998           1997           1996
-------------------------------------------------------------------------------------
<S>                                            <C>            <C>            <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
   Interest received                           $ 16,487       $ 15,020       $ 13,055
   Fees received                                  1,805          1,419            929
   Interest paid                                 (8,476)        (7,422)        (6,934)
   Cash paid to suppliers and associates         (6,982)        (6,488)        (4,623)
-------------------------------------------------------------------------------------
      Net cash provided by
       operating activities                       2,834          2,529          2,427
-------------------------------------------------------------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES:
   Proceeds from sales of securities:
      Available for sale                          3,102          2,479          6,012
   Maturities of securities:
      Available for sale                         33,599         19,404          9,632
   Purchase of securities:
      Available for sale                        (42,252)       (41,235)       (14,360)
   Loans originated to customers, net           (29,484)       (14,578)        (9,704)
   Capital expenditures                          (2,093)          (469)          (310)
-------------------------------------------------------------------------------------
      Net cash used by
         investing activities                   (37,128)       (34,399)        (8,730)
-------------------------------------------------------------------------------------

CASH FLOWS FROM FINANCING ACTIVITIES:
   Net increase in demand, NOW, and
     money market savings                         5,679         15,206         15,767
   Net (decrease) increase in time
      certificates                               (7,225)        15,623        (13,031)
   Advance from Federal Home Loan Bank            5,000          5,000          9,500
   Repayment of advance from Federal
      Home Loan Bank                             (5,000)            --             --
   Proceeds from issuance of common stock        25,061            120             93
   Dividends paid                                  (569)          (441)          (352)
-------------------------------------------------------------------------------------
      Net cash provided by
       financing activities                      22,946         35,508         11,977
-------------------------------------------------------------------------------------

Net (decrease) increase in cash
   and cash equivalents                         (11,348)         3,638          5,674

Cash and cash equivalents at
   beginning of year                             16,591         12,953          7,279
-------------------------------------------------------------------------------------

Cash and cash equivalents at end of year       $  5,243       $ 16,591       $ 12,953
=====================================================================================
</TABLE>


          See accompanying notes to consolidated financial statements.



                                      -34-
<PAGE>   29


                CONSOLIDATED STATEMENTS OF CASH FLOWS - CONTINUED

<TABLE>
<CAPTION>
                                                         Year Ended December 31
(In Thousands)                                      1998          1997          1996
-------------------------------------------------------------------------------------
<S>                                                <C>           <C>           <C>   
Reconciliation of net income to
   net cash provided by operating
   activities:
Net income                                         $2,581        $2,058        $2,547
Adjustments to reconcile net income
   to net cash provided by operating
   activities:
      Depreciation and amortization                   404           399           209
      Provision for loan losses                       128           100            --
      Provision for deferred income taxes             (15)          124            82
      (Gain) loss on sale of securities               (52)           (2)            2
      Loss on disposal of equipment                    26            --            14
      Gain on sale of other real estate owned         (29)           (6)          (11)
      Stock dividend income                          (112)          (87)          (20)
      Changes in assets and liabilities:
        Decrease (increase) in accrued
          interest and other assets                   192          (508)            6
        (Decrease) increase in accounts
          payable and accrued liabilities            (289)          451          (402)
-------------------------------------------------------------------------------------
Net cash provided by operating
   activities                                      $2,834        $2,529        $2,427
=====================================================================================

Supplemental disclosures of noncash investing and financing activities:

Change in unrealized gain (loss) on
   securities available for sale, net
   of taxes                                        $   46        $  230        $ (215)
Foreclosures of loans during the year                  52           133            --

Cash paid for:
   Income taxes                                    $1,516        $1,211        $   77
</TABLE>


          See accompanying notes to consolidated financial statements.



                                      -35-
<PAGE>   30


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

A.       SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

         Description of Operations

                  On April 16, 1996 the shareholders of The Bank of Nashville
                  (The Bank) approved the formation of a holding company. On
                  April 30, 1996 The Bank became a wholly-owned subsidiary of
                  the holding company, Community Financial Group, Inc., (CFGI),
                  a Tennessee Corporation. Each outstanding share of The Bank's
                  common stock was exchanged for an outstanding share of CFGI
                  and each outstanding warrant and each option to purchase
                  shares of The Bank became warrants and options to purchase
                  shares of CFGI.

                  The Bank primarily provides commercial banking services to
                  small business customers located in the Metropolitan
                  Nashville, Tennessee market. The Bank competes with numerous
                  financial institutions within its market place.

         Consolidation and Basis of Presentation

                  The consolidated financial statements include the accounts of
                  CFGI and The Bank (collectively the Company) after elimination
                  of material intercompany accounts and transactions.

                  The accounting and reporting policies of the Company conform
                  to generally accepted accounting principles and to general
                  practices within the banking industry. Management has made a
                  number of estimates and assumptions relating to the reporting
                  of assets and liabilities and the disclosure of contingent
                  assets and liabilities to prepare these consolidated financial
                  statements in conformity with generally accepted accounting
                  principles. Actual results could differ from these estimates.
                  Following is a summary of the more significant accounting
                  policies of the Company.

         Cash and Cash Equivalents

                  Cash and highly liquid investments with maturities of three
                  months or less when purchased are considered to be cash and
                  cash equivalents. Cash and cash equivalents consist primarily
                  of cash and due from banks and federal funds sold net of
                  federal funds purchased.

         Securities

                  Securities are designated as held to maturity, available for
                  sale, or trading at the time of acquisition. The Company does
                  not have securities designated as trading securities or as
                  held to maturity. Held to maturity securities are carried at
                  amortized cost and adjusted for amortization of premiums and
                  accretion of discounts using a method that approximates the
                  level-yield method. Trading account securities are carried at
                  fair value with gains and losses, determined using the
                  specific identification method, recognized currently in the
                  income statement. As of December 31, 1998 and 1997, the
                  Company has classified its entire securities portfolio as
                  available for sale. Available for sale securities are reported
                  at fair value. If a decline in value is considered to be other
                  than temporary, the securities are written down to fair value
                  and the amount of the writedown is included in earnings.
                  Unrealized gains and losses on securities available for sale
                  are reflected in a separate shareholders' equity account, net
                  of applicable income taxes, and in other comprehensive income.
                  The adjusted cost of a specific security sold is used to
                  compute the gain or loss on the



                                      -36-
<PAGE>   31


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

A.       SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - CONTINUED

                  sale of that security. Security purchases and sales are
                  recorded on their trade date. Gains and losses on the sale of
                  securities available for sale are included in non-interest
                  income. Purchased premiums and discounts are amortized and
                  accreted into interest income on a constant yield over the
                  life of the securities taking into consideration current
                  prepayment assumptions.

         Loans

                  Loans are carried at the principal amount outstanding net of
                  unearned income. Interest income on loans and amortization of
                  unearned income is computed by methods which result in level
                  rates of return on principal amounts outstanding. Management,
                  considering current information and events regarding the
                  borrowers ability to repay their obligations, considers a loan
                  to be impaired when it is probable that the Company will be
                  unable to collect all amounts due according to contractual
                  terms of the loan agreement. When a loan is considered
                  impaired, the amount of the impairment is based on the present
                  value of the expected future cash flows at the loan's
                  effective interest rate, at the loan's market price or fair
                  value of collateral if the loan is collateral-dependent.
                  Impairment losses are included in the allowance for loan
                  losses through a charge to provision for loan losses.

                  Interest income is accrued on loans except when doubt as to
                  collectability exists, in which case the respective loans are
                  placed on nonaccrual status. The decision to place a loan on
                  nonaccrual status is based on an evaluation of the borrower's
                  financial condition, collateral liquidation value, and other
                  factors that affect the borrower's ability to pay. At the time
                  a loan is placed on nonaccrual status, the accrued but unpaid
                  interest is charged against current income. Thereafter,
                  interest on nonaccrual loans is recognized as interest income
                  only as received, unless the collectability of outstanding
                  principal is doubtful, in which case such interest received is
                  applied as a reduction of principal until the principal has
                  been recovered, and are recognized as interest income
                  thereafter.

                  Loan origination, commitment fees and certain direct
                  origination costs are deferred and amortized over the
                  contractual life of the related loans, adjusted for
                  prepayments, as a yield adjustment.

         Allowance for Loan Losses

                  The allowance for loan losses reflects an amount which, in
                  management's judgment, is adequate to provide for estimated
                  loan losses. Management's evaluation of the loan portfolio
                  consists of evaluating current delinquencies, the adequacy of
                  underlying collateral, current economic conditions, risk
                  characteristics, and management's internal credit review
                  process. The allowance is established through a provision
                  charged against earnings. Loans are charged off as soon as
                  they are determined to be uncollectible. Recoveries of loans
                  previously charged off are added to the allowance. While
                  management uses available information to recognize losses on
                  loans, future adjustments in the allowance may be necessary
                  based on changes in economic conditions. In addition, various
                  regulatory agencies, as part of their examinations,
                  periodically review the Company's allowance for loan losses.
                  Such agencies may require the Company to adjust the allowance
                  based on their judgment and information available to them at
                  the time of their examinations.



                                      -37-
<PAGE>   32


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

A.       SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - CONTINUED

         Other Real Estate Owned

                  Other real estate owned includes property acquired in
                  situations in which the Company has physical possession of a
                  debtor's assets (collateral). Such assets are carried at the
                  lower of cost or fair value less estimated cost to sell and
                  are included in other assets. Cost includes the fair value of
                  the property at the time of foreclosure, foreclosure expense
                  and expenditures for subsequent improvements. Losses arising
                  from the acquisition of such property are charged against the
                  allowance for loan losses. Declines in value subsequent to
                  foreclosure are recorded as a valuation allowance. Provisions
                  for subsequent declines or losses from disposition of such
                  property are recognized in non-interest expense.

         Premises and Equipment

                  Premises and equipment is stated at cost less accumulated
                  depreciation and amortization. For financial reporting
                  purposes, depreciation and amortization are computed using the
                  straight-line method over the estimated lives of those assets.
                  Leasehold improvements are amortized over the lease terms or
                  the estimated lives, whichever is less. The estimated lives
                  are as follows:

<TABLE>
<CAPTION>
                                                                                        Years
                                                                                        -----
                    <S>                                                                 <C>
                    Leasehold improvements                                              3 - 20
                    Furniture and equipment                                             3 - 10
</TABLE>

         Income Taxes

                  The Company accounts for income taxes in accordance with the
                  asset and liability method of accounting. Under such method,
                  deferred tax assets and liabilities are recognized for the
                  estimated future tax effects attributable to differences
                  between the financial statement carrying amounts of existing
                  assets and liabilities and their respective tax bases.
                  Deferred tax assets and liabilities are measured using enacted
                  tax rates expected to apply to taxable income in the years in
                  which those temporary differences are expected to be recovered
                  or settled. The effect on deferred tax assets and liabilities
                  of a change in tax rates is recognized in the period that
                  includes the enactment date.

         Earnings Per Common Share

                  Basic EPS is computed by dividing net income available to
                  common shareholders (numerator) by the weighted average number
                  of common shares outstanding (denominator). The denominator
                  used in computing diluted EPS reflects the dilutive effect of
                  options and warrants outstanding.



                                      -38-

<PAGE>   33


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

A.       SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - CONTINUED

         Business Segments

                 The Company adopted Statement of Financial Accounting Standards
                 (SFAS) No. 131, "Disclosures about Segments of an Enterprise
                 and Related Information" on December 31, 1998. The Statement
                 establishes standards for the way public business enterprises
                 report information about operating segments in annual financial
                 statements. SFAS No. 131 defines operating segments as
                 components of an enterprise about which separate financial
                 information is available that is regularly evaluated by the
                 chief operating decision maker in deciding how to allocate
                 resources and assess performance. The Company operates in one
                 business segment, commercial banking, and has no additional
                 individually significant business segments.

         Stock-Based Compensation

                 The Company accounts for all stock-based compensation plans
                 under Accounting Principles Board ("APB") Opinion No. 25,
                 "Accounting for Stock Issued to Employees." Compensation cost
                 for stock-based awards is measured by the excess, if any, of
                 the fair market value of the stock over the amount the employee
                 is required to pay. Compensation cost for the Company is
                 measured at the grant date as all options are fixed awards.

         Financial Instruments

                  The Company enters into interest rate floor agreements as part
                  of its asset/liability management program. Fees paid upon
                  inception of these agreements are deferred and amortized over
                  the life of the agreements. Income or expense derived from
                  these agreements is recognized in interest income during the
                  period earned.

         Comprehensive Income

                  The Company adopted SFAS No. 130, "Reporting Comprehensive
                  Income" on January 1, 1998. SFAS No. 130 establishes standards
                  for reporting comprehensive income which includes net income
                  and other comprehensive income, non-owner related transactions
                  in equity. SFAS No. 130 requires only additional disclosures
                  in the consolidated financial statements. During 1998, 1997
                  and 1996 the only component of comprehensive income, other
                  than net income, is unrealized gains or losses on securities
                  available for sale. Prior periods have been reclassified to
                  conform with the provisions of the statement.

         Reclassifications

                  Certain reclassifications have been made in the consolidated
                  financial statements for prior years to conform with the 1998
                  presentation.

B.       CASH RESTRICTIONS

                  The Company is required to maintain reserves in the form of
                  average vault cash and balances with the Federal Reserve Bank.
                  The average amounts of these balances maintained during the
                  years ended December 31, 1998 and 1997, were $3,204,000 and
                  $1,937,000, respectively. The required balance at December 31,
                  1998 was $3,547,000.



                                      -39-
<PAGE>   34


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

C.       SECURITIES

                  The amortized cost, gross unrealized gains and losses, and
                  estimated fair values of securities at December 31, 1998 and
                  1997 were as follows:

<TABLE>
<CAPTION>
                                                                            Available for Sale
                                                      ------------------------------------------------------------
                                                                           Gross           Gross         Estimated
                                                      Amortized         Unrealized       Unrealized         Fair
                                                        Cost               Gains           Losses          Value
         (In Thousands)                                                        1998
         ---------------------------------------------------------------------------------------------------------
         <S>                                          <C>               <C>              <C>             <C>
         U.S. Treasury Securities
           and Obligations of U.S.
           Government agencies                         $35,356             $544             $ -           $35,900
         Collateralized mortgage
           obligations                                  31,758               85              122           31,721
         Securities of states and
           political subdivisions                        1,267               42               -             1,309
         Equity securities                               2,732               -                -             2,732
         --------------------------------------------------------------------------------------------------------

                                                       $71,113             $671             $122          $71,662
         ========================================================================================================
</TABLE>



<TABLE>
<CAPTION>
                                                                            Available for Sale
                                                      ------------------------------------------------------------
                                                                           Gross           Gross         Estimated
                                                      Amortized         Unrealized       Unrealized         Fair
                                                        Cost               Gains           Losses          Value
         (In Thousands)                                                        1997
------------------------------------------------------------------------------------------------------------------
         <S>                                          <C>               <C>              <C>             <C>

         U.S. Treasury Securities
           and Obligations of U.S.
           Government agencies                         $30,859             $573             $  6          $31,426
         Collateralized mortgage
           obligations                                  32,236               79              194           32,121
         Securities of states and
           political subdivisions                          360               22                -              382
         Equity securities                               2,130                -                -            2,130
-----------------------------------------------------------------------------------------------------------------

                                                       $65,585             $674             $200          $66,059
=================================================================================================================
</TABLE>


                  Proceeds from sales of debt securities during 1998, 1997, and
                  1996 were $3.1 million, $2.5 million and $6.0 million,
                  respectively. Gross gains of $52 thousand, $5 thousand and $5
                  thousand and gross losses of zero, $3 thousand and $7 thousand
                  were realized on those sales in 1998, 1997 and 1996,
                  respectively.

                  At December 31, 1998 and 1997, the Company did not have any
                  securities which it classified as held to maturity or trading.

                  The amortized cost and fair value of debt securities by
                  contractual maturity at December 31, 1998, are shown in the
                  following table. Expected maturities will differ from
                  contractual maturities because borrowers may have the right to
                  call or prepay obligations with or without call or prepayment
                  penalties.



                                      -40-
<PAGE>   35


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

C.       SECURITIES - CONTINUED

                  Collateralized mortgage obligations with a weighted average
                  effective yield of 6.09% are disclosed as a separate line item
                  due to staggered maturity dates. Investments in equity
                  securities are excluded as they have no stated maturity date.

<TABLE>
<CAPTION>
                                                                                        Available for Sale
                                                                                ---------------------------------
                                                                                                        Estimated
                                                                                Amortized                  Fair
                                                                                  Cost                    Value
         (In Thousands)                                                                 December 31, 1998
-----------------------------------------------------------------------------------------------------------------
         <S>                                                                    <C>                     <C>
         Due in one year or less                                                 $ 9,990                 $ 9,990
         Due after one year through five years                                     2,032                   2,064
         Due after five years through ten years                                      457                     476
         Due after ten years                                                      24,144                  24,679
-----------------------------------------------------------------------------------------------------------------
                                                                                  36,623                  37,209
         Collateralized mortgage obligations                                      31,758                  31,721
-----------------------------------------------------------------------------------------------------------------

                                                                                 $68,381                 $68,930
=================================================================================================================
</TABLE>


                  Securities with an aggregate amortized cost of approximately
                  $35.7 million and $31.3 million were pledged to secure public
                  deposits, Federal Home Loan Bank borrowings and for other
                  purposes as required by law at December 31, 1998 and 1997,
                  respectively.


D.       LOANS AND ALLOWANCE FOR LOAN LOSSES

                  An analysis of the changes in the allowance for loan losses is
                  as follows:

<TABLE>
<CAPTION>
                                                           Year Ended December 31
      (In Thousands)                                    1998        1997         1996
--------------------------------------------------------------------------------------
      <S>                                              <C>         <C>         <C>    
      Balance, January 1                               $3,128      $2,878      $ 3,034
      Provision charged to operations                     128         100           --
      Loans (charged off), net of recoveries
        of $474, $319 and $541, in 1998,
          1997, and 1996, respectively                    390         150         (156)
--------------------------------------------------------------------------------------

         Balance, December 31                          $3,646      $3,128      $ 2,878
======================================================================================
</TABLE>

                  At December 31, 1998 and 1997, loans on nonaccrual status
                  amounted to $408,000 and $1,094,000, respectively. The effect
                  of nonaccrual loans was to reduce interest income by
                  approximately $29,000 in 1998, $32,000 in 1997 and $74,000 in
                  1996. There were no material commitments to lend additional
                  funds to customers whose loans were classified as nonaccrual
                  at December 31, 1998 and 1997.

                  The Company's recorded investment in impaired loans and the
                  related valuation allowance are $108,000 and $17,000 and
                  $805,000 and $359,000, at December 31, 1998 and 1997,
                  respectively. The valuation allowance is included in the
                  allowance for loan losses on the consolidated balance sheets.
                  At December 31, 1998 and 1997 there were no impaired loans
                  without an accompanying valuation allowance.



                                      -41-
<PAGE>   36


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

D.       LOANS AND ALLOWANCE FOR LOAN LOSSES - CONTINUED

                  The average recorded investment in impaired loans for the
                  years ended December 31, 1998, 1997 and 1996 was $143,000,
                  $390,000 and $382,000, respectively.

                  Interest payments received on impaired loans are recorded as
                  reductions in principal outstanding or recoveries of principal
                  previously charged off. Once the entire principal has been
                  collected any additional payments received are recognized as
                  interest income. No interest income was recognized on impaired
                  loans in 1998 or 1997.

                  In the ordinary course of business, the Company makes loans to
                  directors, executive officers, and principal shareholders,
                  including related interests. In management's opinion, these
                  loans are made on substantially the same terms, including
                  interest and collateral, as those prevailing at the time for
                  comparable transactions with other borrowers and they did not
                  involve more than the normal risk of uncollectability or
                  present other unfavorable features at the time such loans were
                  made. During 1998, $4.3 million of new loans were made while
                  repayments and other reductions totaled $1.1 million.
                  Outstanding loans to executive officers and directors,
                  including their associates and affiliated companies, were $5.4
                  million and $2.2 million at December 31, 1998 and 1997,
                  respectively. Unfunded lines to executive officers and
                  directors were $4.0 and $4.1 million at December 31, 1998 and
                  1997, respectively.

                  The directors, executive officers and principal shareholders
                  also maintain deposits with the Company. The terms of these
                  deposit contracts are comparable to those available to other
                  depositors. The amount of these deposits totaled $2.5 million
                  and $1.3 million at December 31, 1998 and 1997, respectively.


E.       PREMISES AND EQUIPMENT

                  Premises and equipment is summarized as follows:

<TABLE>
<CAPTION>
                                                                           December 31
                  (In Thousands)                                        1998          1997
-------------------------------------------------------------------------------------------
                  <S>                                                 <C>           <C>
                  Land                                                $   638       $    --
                  Leasehold improvements                                  978           577
                  Furniture and equipment                               2,023         1,948
                                                                                    
                  Building and improvements                               298            --
-------------------------------------------------------------------------------------------
                                                                        3,937         2,525
                  Less accumulated depreciation and amortization       (1,211)       (1,548)
-------------------------------------------------------------------------------------------
                  Premises and equipment, net                         $ 2,726       $   977
===========================================================================================
</TABLE>



                                      -42-
<PAGE>   37


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

E.       PREMISES AND EQUIPMENT - CONTINUED

                  The Company occupies space under noncancelable operating
                  leases. The leases provide annual escalating rents for periods
                  through 2003 with options for renewals. Rent expense is
                  recognized in equal monthly amounts over the lease term. Rent
                  expense was $357,000, $345,000 and $284,000 for 1998, 1997 and
                  1996, respectively.

                  Future lease payments under noncancelable operating leases at
                  December 31, 1998 are payable as follows:

<TABLE>
<CAPTION>
                 (In Thousands)
--------------------------------------------------------------------------------
                  <S>                                              <C>
                  1999                                             $410
                  2000                                              239
                  2001                                              171
                  2002                                               92
                  2003                                               38
--------------------------------------------------------------------------------
                                                                   $950
================================================================================
</TABLE>


F.       INCOME TAXES

                  Actual income tax expense for the years ended December 31,
                  1998, 1997 and 1996 differed from an "expected" tax expense
                  (computed by applying the U.S. Federal corporate tax rate of
                  34% to income before income taxes)as follows:

<TABLE>
<CAPTION>
                  (In Thousands)                                           1998           1997           1996
--------------------------------------------------------------------------------------------------------------
                  <S>                                                     <C>            <C>              <C>
                  Computed "expected" tax expense                         $1,415         $1,152           $923
                  State taxes, net of federal benefit                        163            135             -
                  Benefit of net operating
                   loss carryforward                                          -              -            (755)
                  Other                                                        3             44             -
--------------------------------------------------------------------------------------------------------------
                  Total income tax expense                                $1,581         $1,331           $168
==============================================================================================================
</TABLE>


                  The components of income tax expense (benefit) were as
                  follows:

<TABLE>
<CAPTION>
                  (In Thousands)                               1998          1997       1996
--------------------------------------------------------------------------------------------
                  <S>                                         <C>           <C>         <C>
                  Current income tax expense:
                    Federal                                   $ 1,347       $1,107      $ 86
                    State                                         249          100        --
--------------------------------------------------------------------------------------------
                                                                1,596        1,207        86
--------------------------------------------------------------------------------------------
                  Deferred income tax expense (benefit):
                    Federal                                       (13)          20        82
                    State                                          (2)         104        --
--------------------------------------------------------------------------------------------
                                                                  (15)         124        82
--------------------------------------------------------------------------------------------

                  Total income tax expense                    $ 1,581       $1,331      $168
============================================================================================
</TABLE>



                                      -43-
<PAGE>   38


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

F.       INCOME TAXES- CONTINUED

                  Significant temporary differences and carryforwards that give
                  rise to the deferred tax assets and liabilities are as
                  follows:

<TABLE>
<CAPTION>
                                                                   December 31
                  (In Thousands)                                  1998      1997
--------------------------------------------------------------------------------
                  <S>                                             <C>       <C>
                  Deferred tax assets:
                  Deferred fees, principally due to timing
                    differences in the recognition of income      $141      $147
                  Other                                              4        10
--------------------------------------------------------------------------------
                    Total gross deferred tax assets                145       157
--------------------------------------------------------------------------------


                  Deferred tax liabilities:
                  Unrealized gain on securities
                    available for sale                             209       180
                  Discount on securities deferred
                    for tax purposes                               130       108
                  Loans, principally due to provision for
                   loan losses                                     126       174
                  Premises and equipment, principally due to
                    differences in depreciation methods             17        38
                  Other                                             63        43
--------------------------------------------------------------------------------
                    Total gross deferred tax liabilities           545       543
--------------------------------------------------------------------------------

                  Net deferred tax liabilities                    $400      $386
================================================================================
</TABLE>

                  It is more likely than not that the results of the Company's
                  future operations will generate sufficient taxable income to
                  realize the deferred tax assets.


G.       LONG TERM DEBT AND LINES OF CREDIT

                  The Bank maintains an arrangement with the Federal Home Loan
                  Bank of Cincinnati to provide for certain borrowing needs of
                  The Bank. The arrangement requires The Bank to hold stock in
                  the Federal Home Loan Bank and requires The Bank to pledge
                  investment securities or loans, to be held by the Federal Home
                  Loan Bank, as collateral. During 1998, loans totaling
                  $5,000,000 were advanced and repaid. During 1997, $5,000,000
                  was advanced under this arrangement. At December 31, 1998 and
                  1997 indebtedness under the arrangement totaled $14,500,000.
                  Advances of $9,500,000 mature in September, 2001 and
                  $5,000,000 November 2003, and are eligible for prepayment at
                  The Bank's option beginning in September, 1998 and November,
                  2000. The interest rate on $9,500,000 of the advances is tied
                  to the one-month LIBOR rate and adjusts periodically. Interest
                  on the $5,000,000 advance is at 4.45% for two years and then
                  adjusts quarterly to the three month LIBOR rate. Interest is
                  payable monthly. The maximum advances outstanding were
                  $14,500,000, the average balances outstanding were $12,144,000
                  and $12,651,000 and the weighted average rates were 5.56% for
                  the years ended 1998 and 1997, respectively. The Bank has
                  pledged investment securities with an amortized cost of
                  approximately $15.2 million at December 31, 1998 as collateral
                  under terms of the loan agreement.



                                      -44-
<PAGE>   39


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

G.       LONG TERM DEBT AND LINES OF CREDIT - CONTINUED

                  On December 31, 1998 and 1997, the Company had available for
                  its use $26.5 million and $19.0 million, respectively, of
                  unsecured short-term bank lines of credit. Such short-term
                  lines serve as backup for loan and investment needs. There are
                  no compensating balance requirements. These lines facilitate
                  federal funds borrowings and bear a rate equal to the current
                  lending rate for federal funds purchased. Amounts outstanding
                  under these lines of credit at December 31, 1998 and 1997 were
                  $8.0 million and $0, respectively.

H.       FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK

                  The Company is a party to financial instruments with
                  off-balance sheet risk in the normal course of business to
                  meet the financing needs of its customers and to reduce its
                  own exposure to fluctuations in interest rates. These
                  financial instruments include commitments to extend credit and
                  standby letters of credit. Those instruments involve, to
                  varying degrees, elements of credit and interest rate risk in
                  excess of the amount recognized on the balance sheets. The
                  contract amounts of those instruments reflect the extent of
                  involvement and the related credit risk the Company has in
                  particular classes of financial instruments. The Company,
                  through regular reviews of these arrangements, does not
                  anticipate any material losses as a result of these
                  transactions.

                  At December 31, 1998 and 1997 unused lines of credit were
                  approximately $58.2 million and $53.0 million, respectively,
                  with the majority generally having terms at origination of one
                  year. Additionally, the Company had standby letters of credit
                  of $4,832,000 and $3,039,000 at December 31, 1998 and 1997,
                  respectively.

                  Commitments to extend credit are agreements to lend to a
                  customer as long as there is no violation of any condition
                  established in the contract. Commitments generally have fixed
                  expiration dates or other termination clauses and may require
                  payment of a fee. Since many of the commitments are expected
                  to expire without being drawn upon, the total commitment
                  amounts do not necessarily represent future cash requirements.
                  The Company evaluates each customer's credit worthiness on a
                  case-by-case basis. The amounts of collateral obtained, if
                  deemed necessary by the Company, upon extension of credit is
                  based on management's credit evaluation of the customer.

                  Standby letters of credit are commitments issued by the
                  Company to guarantee the performance of a customer to a third
                  party. Those guarantees are primarily issued to support public
                  and private borrowing arrangements, including commercial
                  paper, bond financing, and similar transactions. Most
                  guarantees extend from one to two years. The credit risk
                  involved in issuing letters of credit is essentially the same
                  as that involved in extending loan facilities to customers.



                                      -45-
<PAGE>   40


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

I.       SIGNIFICANT CONCENTRATIONS OF CREDIT RISK

                  Most of the Company's business activity is with customers
                  located in the Middle Tennessee region. Generally, loans are
                  secured by stocks, real estate, time certificates, or other
                  assets. The loans are expected to be repaid from cash flow or
                  proceeds from the sale of selected assets of the borrowers.
                  The Company grants residential, consumer, and commercial loans
                  to customers throughout the Middle Tennessee region. Real
                  estate mortgage and construction loans reflected in the
                  accompanying consolidated balance sheets are comprised
                  primarily of loans to commercial borrowers.

                  At December 31, 1998 funded and unfunded loan commitments as
                  classified by Standard Industry Classification codes include
                  borrowers in the real estate industry approximating $27.2
                  million and $5.2 million, respectively, and loans to building
                  contractors approximating $8.8 million and $10.1 million,
                  respectively. At December 31, 1997, funded and unfunded
                  commitments to borrowers in the real estate industry were
                  approximately $25 million and $2.2 million, respectively, and
                  to building contractors approximately $7.9 million and $11.2
                  million, respectively.

J.       EMPLOYEE BENEFITS

                  The Company maintains for its employees an Associates Stock
                  Purchase Plan and a Retirement Savings Plan 401(K).

                  The Retirement Savings Plan 401(K) provides for the maximum
                  deferral of employee compensation allowable by the IRS under
                  provisions of Section 401(A) and 401(K). The Plan is available
                  to all associates who meet the plan eligibility requirements.
                  The Company provides various levels of employer matching of
                  contributions up to 4% of the associate's compensation.
                  Employer contributions are invested exclusively in the
                  Company's common stock. Associates fully vest in the
                  employer's contributions after three years of service as
                  defined in the Plan. Total plan expense for 1998, 1997 and
                  1996 was approximately $88,000, $77,000, and $61,000,
                  respectively.

                  In 1997, the Board of Directors adopted the 1997 Nonstatutory
                  Stock Option Plan which reserved 150,000 shares of the
                  Company's common stock for use under the Plan (plus 10% of any
                  additional shares of stock issued after the effective date of
                  the Plan). Stock issued pursuant to the Plan may be either
                  authorized but unissued shares or shares held in the treasury
                  of the Company. Options are granted at an option price of no
                  less than the fair market value of the stock on the date of
                  grant. Each grant of an option shall be evidenced by a stock
                  option agreement specifying the number of shares, the exercise
                  price, and a vesting schedule. During 1998 and 1997, 45,177
                  options, and 23,000 options, respectively, were granted under
                  the Plan.

                  The Associates Stock Purchase Plan (ASPP), under which 100,000
                  shares of the Company's common stock may be issued, allows
                  associates to purchase the Company's common stock through
                  payroll deductions at 84% of the existing market value, not to
                  fall below par value. The difference between the purchase
                  price and the market value on the date of issue is recorded as
                  compensation expense. Compensation expense of $16,000, $9,000
                  and $2,000 was recorded in 1998, 1997 and 1996, respectively.
                  Incidental expenses regarding the administration of the plan
                  are paid by the Company.



                                      -46-
<PAGE>   41


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

J.       EMPLOYEE BENEFITS - CONTINUED

                  As of December 31, 1998, the Company's Board of Directors had
                  approved the issuance of stock options to purchase 142,627
                  shares of the Company's common stock. Compensation expense was
                  not recorded in connection with the issuance of these options
                  as the option price was equal to or exceeded the market price
                  of the Company's common stock at the date of grant. The
                  following table presents information on stock options:

<TABLE>
<CAPTION>
                                                                                               Weighted
                                                    Total     Exercisable       Option         Average
                      Option Shares                Options      Options       Price Range       Price
------------------------------------------------------------------------------------------------------
                  <S>                              <C>        <C>           <C>                <C>
                  Options outstanding
                    at January 1, 1996             65,000       51,000      $  6.00-7.125      $ 6.59
                  Granted                          15,000        3,000      $      10.125      $10.125
                  Options that became
                    exercisable                        --        8,000      $  6.00-7.125      $ 6.813
                  Options exercised                (5,000)      (5,000)     $       7.125      $ 7.125
------------------------------------------------------------------------------------------------------
                  Options outstanding at
                    December 31, 1996              75,000       57,000      $ 6.00-10.125      $ 7.26
                  Granted                          22,450        4,490      $      11.625      $11.625
                  Options that became
                    exercisable                        --        9,000      $ 7.00-10.125      $ 8.10
------------------------------------------------------------------------------------------------------
                  Options outstanding at
                    December 31, 1997              97,450       70,490      $ 6.00-11.625      $ 8.28
                  Granted                          45,177        9,035      $      14.75       $14.75
                  Options that became
                    exercisable                        --        7,490      $7.125-11.625      $11.02
------------------------------------------------------------------------------------------------------
                  Options outstanding at
                    December 31, 1998             142,627       87,015     $  6.00-14.75       $10.32
-----------------------------------------------------------------------------------------------------
</TABLE>

                  The stock options have five year vesting schedules and become
                  exercisable in full in the event of a merger, sale or change
                  in majority control of the Company. The options expire during
                  the years 2002 through 2007. The weighted average price of the
                  options at December 31, 1998 was $10.32 and the weighted
                  average remaining life was approximately 7.3 years.

                  The Company accounts for its stock option plan and ASPP in
                  accordance with the provisions of Accounting Principles Board
                  (APB) Opinion No. 25, Accounting for Stock Issued to
                  Employees, and related interpretations. As such, compensation
                  expense related to stock options would be recorded on the date
                  of grant only if the current market price of the underlying
                  stock exceeded the exercise price. Had the Company used the
                  provisions of SFAS No. 123, Accounting for Stock-Based
                  Compensation, the Company would have recognized, as expense
                  over the vesting period, the fair value of all stock-based
                  awards on the date of grant. The Company has elected to
                  continue to apply the provisions of APB No. 25. As such,
                  proforma disclosures of net income and earnings per share as
                  if the fair value based method of SFAS No. 123 had been used,
                  are as follows:



                                      -47-
<PAGE>   42


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

J.       EMPLOYEE BENEFITS - CONTINUED

<TABLE>
<CAPTION>
                                                                1998                  1997              1996
--------------------------------------------------------------------------------------------------------------
                  <S>                                        <C>                   <C>              <C>
                  Net income - as reported                   $2,581,000            $2,058,000       $2,547,000
                  Net income - proforma                      $2,543,000            $2,045,000       $2,543,000
                  Earnings per share:
                    Basic
                      As reported                            $     1.08            $      .93       $     1.16
                      Proforma                               $     1.06            $      .93       $     1.16
                    Diluted
                      As reported                            $      .78            $      .89       $     1.15
                      Proforma                               $      .77            $      .88       $     1.14
==============================================================================================================
</TABLE>

                  The weighted average fair values of options granted during
                  1998, 1997 and 1996 were $5.79, $3.95 and $2.97 per share,
                  respectively. The fair value of each option grant is estimated
                  on the date of grant using the Black-Scholes option-pricing
                  model with the following assumptions:

<TABLE>
<CAPTION>
                                                                          1998             1997           1996
--------------------------------------------------------------------------------------------------------------
                  <S>                                                     <C>              <C>           <C>
                  Expected dividend yield                                 2.13%            1.78%         1.42%
                  Expected stock price volatility                           22%              20%           19%
                  Risk-free interest rate                                 5.66%            6.64%         6.61%
                  Expected life of options(years)                            5                5             5
==============================================================================================================
</TABLE>


K.       SHAREHOLDERS' EQUITY AND EARNINGS PER SHARE

                  The Company can issue common stock pursuant to various plans
                  such as employee stock purchase, contributions to the 401(K)
                  plan, and payment of directors' fees. Under these plans,
                  7,304, 4,417 and 5,973 shares were issued during 1998, 1997
                  and 1996, respectively.

                  The Company had outstanding stock options totaling 142,627 and
                  97,450 shares at December 31, 1998 and 1997, respectively.
                  Options totaling 45,177 shares were issued during 1998.
                  Options totaling 22,450 shares were issued during 1997.

                  At December 31, 1997, warrants to purchase 4,739,397, shares
                  of CFGI's common stock at a price of $12.50 per share were
                  outstanding. During 1998 and 1997, warrants for 1,996,807
                  shares and 5,530 shares were exercised with proceeds of
                  $24,960,087 and $69,125, respectively. The unexercised
                  warrants expired on December 31, 1998.



                                      -48-
<PAGE>   43


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

K.       SHAREHOLDERS' EQUITY AND EARNINGS PER SHARE - CONTINUED

                  The following table is a reconciliation of net income and
                  average shares outstanding used in calculating basic and
                  diluted earnings per share.

<TABLE>
<CAPTION>
                                              Year Ended December 31
(Dollars in Thousands,
  Except Per Share Data)               1998            1997            1996
--------------------------------------------------------------------------------
<S>                                 <C>             <C>             <C>
Net income available to common
  shareholders                      $    2,581      $    2,058      $    2,547
--------------------------------------------------------------------------------

Weighted average common shares
 outstanding
   Basic                             2,393,576       2,205,043       2,198,619

Dilutive effect of:
   Options                              40,090          30,687          24,034
   Warrants                            887,562          87,850              --
--------------------------------------------------------------------------------

Weighted average common shares
 outstanding
   Diluted                           3,321,228       2,323,580       2,222,653
--------------------------------------------------------------------------------

Antidilutive securities:
   Warrants                                 --               *       4,744,927
--------------------------------------------------------------------------------

Net income per share:
   Basic                            $     1.08      $      .93      $     1.16
   Diluted                          $      .78      $      .89      $     1.15
--------------------------------------------------------------------------------
</TABLE>

* The warrants were dilutive beginning in the fourth quarter of 1997.

                  In January, 1998, the Company's Board of Directors adopted a
                  Shareholder Rights Plan which authorizes the distribution of a
                  dividend of one common share purchase right for each
                  outstanding share of CFGI's common stock. The rights will be
                  exercisable only if a person or group acquires 15% or more of
                  CFGI's common stock or announces a tender offer, the
                  consummation of which would result in ownership by a person or
                  group of 15% or more of the common stock. The rights are
                  designed to assure that all of CFGI's shareholders receive
                  fair and equal treatment in the event of any proposed takeover
                  of the Company and to guard against partial tender takeovers,
                  squeeze outs, open market accumulations and other abusive
                  tactics to gain control of the Company without paying all
                  shareholders an appropriate control premium.

                  If the Company were acquired in a merger or other business
                  combination transaction, each right would entitle its holder
                  to purchase, at the right's then current exercise price, a
                  number of the acquiring company's common shares having a
                  market value of twice such a price. In addition, if a person
                  or group acquires 15% or more of CFGI's common stock, each
                  right would entitle its holder (other than the acquiring
                  person or members of the acquiring group) to purchase, at the
                  rights then current exercise price, a number of CFGI's common
                  shares having a market value of twice that price. After a
                  person or group acquires beneficial ownership of 15% or more
                  of CFGI's common stock and before an acquisition of 50% or
                  more of the common stock, the Board of Directors would
                  exchange the rights (other than rights owned by the acquiring
                  person or group), in whole or in part, at an exchange ratio of
                  one share of common stock per right.



                                      -49-
<PAGE>   44


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

K.       SHAREHOLDERS' EQUITY AND EARNINGS PER SHARE - CONTINUED

                  Until a person or group has acquired beneficial ownership of
                  15% or more of CFGI's common stock, the rights will be
                  redeemable for $.01 per right at the option of the Board of
                  Directors. The rights are intended to enable all CFGI's
                  shareholders to realize the long-term value of their
                  investment in the Company. The Company believes they will not
                  prevent a takeover, but should encourage anyone seeking to
                  acquire the Company to negotiate with the Board prior to
                  attempting a takeover.

L.       RESTRICTIONS ON RETAINED EARNINGS, REGULATORY MATTERS AND LITIGATION

                  In order to declare dividends The Bank must transfer a minimum
                  of ten percent of current net income from retained earnings to
                  additional paid-in capital until additional paid-in capital
                  equals common stock. At December 31, 1998, approximately $5.7
                  million of The Bank's retained earnings were available for
                  dividend declaration and payment to its shareholder CFGI
                  (parent company), without regulatory approval.

                  The Bank transferred $258,000 and $147,000 from retained
                  earnings to surplus during 1998 and 1997, respectively.
                  Additionally, during 1996, The Bank transferred a net of
                  $1,851,000 from additional paid-in capital to retained
                  earnings. The Bank transferred $187,000 from retained earnings
                  to additional paid-in capital, subsequent to, its acquisition
                  by CFGI.

                  CFGI and The Bank are subject to various regulatory capital
                  requirements administered by the federal banking agencies.
                  Failure to meet minimum capital requirements can initiate
                  certain mandatory - and possibly additional discretionary -
                  actions by regulators that, if undertaken, could have a direct
                  material effect on the Company's consolidated financial
                  statements. Under capital adequacy guidelines and the
                  regulatory framework for prompt corrective action, the Company
                  and The Bank must meet specific capital guidelines that
                  involve quantitative measures of the Company's and The Bank's
                  assets, liabilities, and certain off-balance-sheet items as
                  calculated under regulatory accounting practices. The
                  Company's and The Bank's capital amounts and classification
                  are also subject to qualitative judgments by the regulators
                  about components, risk weightings, and other factors.

                  Quantitative measures established by regulation to ensure
                  capital adequacy require the Company and The Bank to maintain
                  minimum amounts and ratios (set forth in the following table)
                  of total and Tier I capital (as defined in the regulations) to
                  risk-weighted assets (as defined), and of Tier I capital (as
                  defined) to average assets (as defined). Management believes
                  the Company and The Bank meet all capital adequacy
                  requirements to which it is subject as of December 31, 1998.

                  As of December 31, 1998, the most recent notification from the
                  Federal Reserve Bank categorized The Bank as well capitalized
                  under the regulatory framework for prompt corrective action.
                  To be categorized as adequately capitalized, The Bank must
                  maintain minimum total risk-based, Tier I risk-based, and Tier
                  I leverage ratios as set forth in the table below. There are
                  no conditions or events since that notification that
                  management believes have changed The Bank's category.



                                      -50-
<PAGE>   45


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

L.       RESTRICTIONS ON RETAINED EARNINGS, REGULATORY MATTERS AND
         LITIGATION - CONTINUED

                  The Company's and The Bank's actual capital amounts and ratios
                  are also presented in the table.

CAPITAL RATIOS

<TABLE>
<CAPTION>
                                                 CFGI                             The Bank
                                               December 31                       December 31
(Dollars In Thousands)                    1998            1997            1998                1997
----------------------------------------------------------------------------------------------------
<S>                                    <C>             <C>             <C>                  <C>     
CAPITAL COMPONENTS
  TIER 1 CAPITAL:
    Shareholders' equity               $  51,171       $  24,052       $  26,474            $ 23,865
    Unrealized gain on securities           (340)           (294)           (340)               (294)
----------------------------------------------------------------------------------------------------
        Total Tier 1 capital              50,831          23,758          26,134              23,571

TIER 2 CAPITAL:
    Allowable allowance for
      loan losses                          2,113           1,714           2,107               1,713
        Total capital                  $  52,944       $  25,472       $  28,241            $ 25,284
----------------------------------------------------------------------------------------------------

Risk-adjusted assets                   $ 167,527       $ 135,674       $ 166,997            $135,639
Quarterly average assets               $ 220,645       $ 200,594       $ 220,398            $200,560
</TABLE>


<TABLE>
<CAPTION>
                                            Regulatory
                                              Minimum                CFGI               The Bank
                                              Ratios             December 31           December 31
                                                              1998        1997       1998       1997
----------------------------------------------------------------------------------------------------
<S>                                         <C>               <C>        <C>         <C>       <C>
CAPITAL RATIOS
  Total risk-based capital ratio                8%            31.6%      18.8%       16.9%     18.6%
  Tier 1 risk-based capital ratio               4%            30.3%      17.5%       15.6%     17.4%
  Tier 1 leverage ratio                         4%            23.0%      11.8%       11.9%     11.8%
</TABLE>


                  There are from time to time legal proceedings pending against
                  the Company. In the opinion of management, liabilities, if
                  any, arising from such proceedings presently pending would not
                  have a material adverse effect on the consolidated financial
                  statements of the Company.



                                      -51-
<PAGE>   46


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

M.       FAIR VALUE OF FINANCIAL INSTRUMENTS

                  SFAS No. 107, "Disclosures about Fair Value of Financial
                  Instruments," requires disclosure of fair value information
                  about financial instruments for both on and off-balance sheet
                  assets and liabilities for which it is practicable to estimate
                  fair value. The techniques used for this valuation are
                  significantly affected by the assumptions used, including the
                  amount and timing of future cash flows and the discount rate.
                  Such estimates involve uncertainties and matters of judgment
                  and, therefore, cannot be determined with precision. In that
                  regard, the derived fair value estimates cannot be
                  substantiated by comparison to independent markets.
                  Accordingly, the aggregate fair value amounts presented are
                  not meant to represent the underlying value of the Company.

                  The following table presents the carrying amounts and the
                  estimated fair value of the Company's financial instruments at
                  December 31:

<TABLE>
<CAPTION>
                                                                              Estimated                    Estimated
                                                                Carrying        Fair        Carrying          Fair
                                                                 Amount         Value         Value          Value
        (In Thousands)                                                    1998                       1997
-------------------------------------------------------------------------------------------------------------------
                  <S>                                           <C>            <C>            <C>          <C>
                  Financial assets:
                     Cash, due from banks,
                       and federal funds sold                   $ 13,243       $ 13,243       $16,591      $ 16,591
                     Investment securities                        71,662         71,662        66,059        66,059
                     Loans, net of unearned
                       income                                    152,675        153,113       122,749       122,646

                  Financial liabilities:
                     Deposits                                    162,553        162,893       164,099       164,564
                     Federal Home Loan
                       Bank and other
                        borrowings                                22,500         22,676        14,500        14,503
-------------------------------------------------------------------------------------------------------------------
</TABLE>


<TABLE>
<CAPTION>
                                                          Contractual                     Contractual
                                                             or           Estimated           or          Estimated
                                                           Notional         Fair           Notional          Fair
                                                            Amounts         Value           Amounts          Value
                  (In Thousands)                                     1998                            1997
                  <S>                                     <C>             <C>             <C>             <C>
                  Off-balance items:
                     Interest rate floors                   $    --          $  *             8,000            $  *
                     Commitments to
                       extend credit                         58,207             *            53,023               *
                     Standby letters
                       of credit                              4,832             *             3,039               *
-------------------------------------------------------------------------------------------------------------------
            *  The estimated fair value of these items was not significant at December 31, 1998 or 1997.
</TABLE>



                                      -52-
<PAGE>   47


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

M.       FAIR VALUE OF FINANCIAL INSTRUMENTS

                  The following summary presents the methodologies and
                  assumptions used to estimate the fair value of the Company's
                  financial instruments presented above.

                  Cash, Due from Banks and Federal Funds Sold

                  For cash, due from banks and federal funds sold, the carrying
                  amount is a reasonable estimate of fair value. These
                  instruments expose the Company to limited credit risk and
                  carry interest rates which approximate market.

                  Investment Securities

                  In estimating fair values, management makes use of prices or
                  dealer quotes for U.S. Treasury securities, other U.S.
                  government agency securities, and collateralized mortgage
                  obligations, securities of states and political subdivisions,
                  and equity securities. As required, securities available for
                  sale are recorded at fair value.

                  Loans

                  The fair value of loans is estimated by discounting the future
                  cash flows using the current rates at which similar loans
                  would be made to borrowers with similar credit ratings for the
                  same remaining maturities adjusted for differences in loan
                  characteristics. The risk of default is measured as an
                  adjustment to the discount rate, and no future interest income
                  is assumed for nonaccrual loans.

                  The fair value of loans does not include the value of the
                  customer relationship or the right to fees generated by the
                  account.

                  Deposit Liabilities

                  The fair value of deposits with no stated maturities (which
                  includes demand deposits, NOW accounts, and money market
                  deposits) is the amount payable on demand at the reporting
                  date. The fair value of fixed-maturity certificates of deposit
                  is estimated using a discounted cash flow model based on the
                  rates currently offered for deposits of similar maturities.

                  SFAS No. 107 requires deposit liabilities with no stated
                  maturity to be reported at the amount payable on demand
                  without regard for the inherent funding value of these
                  instruments. The Company believes that significant value
                  exists in this funding source.

                  Federal Home Loan Bank and Other Borrowings

                  The fair value of Federal Home Loan Bank borrowings is
                  estimated using discounted cash flows, based on current
                  incremental borrowing rates for similar types of borrowing
                  arrangements.



                                      -53-
<PAGE>   48


N.       OTHER COMPREHENSIVE INCOME

                  SFAS No. 130, "Reporting Comprehensive Income" was adopted by
                  the Company on January 1, 1998. SFAS No. 130 establishes
                  standards for reporting comprehensive income. Comprehensive
                  income includes net income and other comprehensive income
                  which is defined as nonowner related transactions in equity.
                  Prior periods have been reclassified to reflect the provisions
                  of SFAS No. 130. The statement requires the Company's
                  unrealized gains and losses (net of tax) on securities
                  available for sale to be included in other comprehensive
                  income. The amounts of other comprehensive income included in
                  equity along with the related tax effect are set forth in the
                  table below:

<TABLE>
<CAPTION>
                                                                           Gain (Loss)         Tax           Net of
                  (Dollars In Thousands)                                   Before Tax        Expense           Tax
                  <S>                                                      <C>               <C>             <C>
                  Year ended December 31, 1998
                  Net unrealized gain on securities
                    available for sale arising
                    during 1998                                                $127            $49             $78
                  Less:  Reclassification adjustment
                           for net gains included in
                           net income                                            52             20              32
-------------------------------------------------------------------------------------------------------------------
                  Other comprehensive income                                   $ 75            $29             $46
===================================================================================================================
                  Year ended December 31, 1997
                  Net unrealized gain on securities
                    available for sale arising
                    during 1997                                                $373           $142            $231
                  Less:  Reclassification adjustment
                           for net gains included in
                           net income                                             2              1               1
-------------------------------------------------------------------------------------------------------------------
                  Other comprehensive income                                   $371           $141            $230
===================================================================================================================

                  Year ended December 31, 1996
                  Net unrealized loss on securities
                    available for sale arising
                    during 1996                                               $(178)           $38           $(216)
                  Less:  Reclassification adjustment
                           for net losses included in
                           net income                                            (2)             1              (1)
-------------------------------------------------------------------------------------------------------------------
                  Other comprehensive income                                  $(176)           $39           $(215)
===================================================================================================================
</TABLE>



                                      -54-
<PAGE>   49


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

O.       PARENT COMPANY FINANCIAL INFORMATION

                  Condensed financial information for Community Financial Group,
                  Inc., (Parent Company only) as of December 31, 1998 and 1997,
                  for the years ended December 31, 1998 and 1997 and the period
                  from May 1, 1996 to December 31, 1996 was as follows:

         Condensed Balance Sheets

<TABLE>
<CAPTION>
                                                                                           December 31
         (In thousands)                                                          1998                     1997
----------------------------------------------------------------------------------------------------------------
         <S>                                                                   <C>                       <C>
         Assets
           Cash                                                                $ 14,229                  $   155
           Investment in bank subsidiary, at cost
             adjusted for equity in earnings                                     26,474                   23,865
           Securities available for sale
             (Amortized cost of $10,490)                                         10,490                      -
           Other assets                                                              24                       33
----------------------------------------------------------------------------------------------------------------
                  Total Assets                                                  $51,217                  $24,053
================================================================================================================
         Liabilities and Shareholders' Equity
           Other liabilities                                                    $    46                  $     1
----------------------------------------------------------------------------------------------------------------
                  Total Liabilities                                                  46                        1
                  Total Shareholders' Equity                                     51,171                   24,052
----------------------------------------------------------------------------------------------------------------
                  Total Liabilities and
                    Shareholders' Equity                                        $51,217                  $24,053
================================================================================================================
</TABLE>



         Condensed Income Statements

<TABLE>
<CAPTION>
                                                                                                      Eight Month
                                                          Year Ended            Year Ended           Period Ended
                                                          December 31           December 31           December 31
         (In Thousands)                                      1998                 1997                   1996
----------------------------------------------------------------------------------------------------------------
         <S>                                              <C>                   <C>                  <C>
         Income
           Dividends from bank subsidiary                   $  133               $  530                   $  231
           Interest income                                       1                  -                        -
----------------------------------------------------------------------------------------------------------------
                  Total income                                 134                  530                      231
----------------------------------------------------------------------------------------------------------------

         Expenses
           Interest expense on short-term
             borrowings                                        -                     -                         1
           Other expenses                                      186                  165                       50
----------------------------------------------------------------------------------------------------------------
                  Total expenses                               186                  165                       51
----------------------------------------------------------------------------------------------------------------

         Income (loss) before income taxes                     (52)                 365                      180
         Increase to consolidated
           income taxes arising from parent
           company taxable income                               70                   63                       19
         Equity in undistributed earnings
           of subsidiary bank                                2,563                1,630                    2,348
----------------------------------------------------------------------------------------------------------------
         Net income                                         $2,581               $2,058                   $2,547
================================================================================================================
</TABLE>



                                      -55-
<PAGE>   50


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

O.       PARENT COMPANY FINANCIAL INFORMATION - CONTINUED

         Statements of Cash Flows

<TABLE>
<CAPTION>
                                                                                                      Eight Month
                                                         Year Ended          Year Ended              Period Ended
                                                        December 31,        December 31,              December 31
         (In Thousands)                                     1998                 1997                   1996
         <S>                                            <C>                 <C>                      <C>
         Operating activities
           Net income                                      $ 2,581               $2,058                  $2,547
           Adjustments to reconcile net
             income to net cash provided
             by operating activities:
               Undistributed earnings of
                    bank subsidiary                         (2,563)              (1,630)                 (2,348)
                  Decrease (increase) in
                    other assets                                 9                   28                     (43)
                  Increase (decrease) in
                    other liabilities                           45                  (17)                     18
---------------------------------------------------------------------------------------------------------------
                    Net cash provided by                                                                    
                     operating activities                       72                  439                     174
---------------------------------------------------------------------------------------------------------------
         Investment activities
           Purchases of securities                         (10,490)                  -                       -
---------------------------------------------------------------------------------------------------------------
           Cash used by investing
             activities                                    (10,490)                  -                       -
---------------------------------------------------------------------------------------------------------------
         Financing activities
           Repayment of short-term
             borrowing                                         -                     -                      (20)
           Proceeds from issuance of
             common stock                                   25,061                  120                      56
           Cash dividends paid                                (569)                (441)                   (176)
---------------------------------------------------------------------------------------------------------------
                    Net cash provided by
                      (used in) financing
                      activities                            24,492                 (321)                   (140)
---------------------------------------------------------------------------------------------------------------
         Increase in cash                                   14,074                  118                      34
         Cash beginning of period                              155                   37                       3
---------------------------------------------------------------------------------------------------------------
         Cash end of year                                  $14,229                $ 155                  $   37
---------------------------------------------------------------------------------------------------------------

</TABLE>



                                      -56-
<PAGE>   51


REPORT OF MANAGEMENT'S RESPONSIBILITY FOR FINANCIAL REPORTING


The management of Community Financial Group, Inc. and subsidiary (the Company)
is responsible for preparing the accompanying consolidated financial statements
in accordance with generally accepted accounting principles. The amounts therein
are based on management's best estimates and judgments. Management has also
prepared other information in the annual report and is responsible for its
accuracy and consistency with the consolidated financial statements.

The Company maintains a system of internal accounting control which it believes,
taken as a whole, is sufficient to provide reasonable assurance that assets are
properly safeguarded and that transactions are executed in accordance with
proper authorization and are recorded and reported properly. In establishing and
maintaining any system of internal accounting control, estimates and judgments
are required to assess the relative costs and expected benefits. The Company
also maintains a program that independently assesses the effectiveness of their
internal controls.

The Company's consolidated financial statements have been audited by independent
certified public accountants. Their Independent Auditors' Report, which follows,
is based on an audit made in accordance with generally accepted auditing
standards and expresses an opinion as to the fair presentation of the Company's
consolidated financial statements. In performing their audit, the Company's
independent certified public accountants consider the Company's internal control
to the extent they deem necessary in order to issue their opinion on the
consolidated financial statements.

The Board of Directors pursues its oversight role for the consolidated financial
statements through the Audit Committee, which consists solely of outside
directors. The Audit Committee meets periodically with both management and the
independent auditors to assure that each is carrying out its responsibilities.




/s/ Mack S. Linebaugh, Jr.
----------------------------------
Mack S. Linebaugh, Jr.
Chairman of the Board
President and CEO



                                      -57-
<PAGE>   52


Independent Auditors' Report


The Board of Directors and Shareholders
Community Financial Group, Inc.:


We have audited the accompanying consolidated balance sheets of Community
Financial Group, Inc. and subsidiary (the Company) as of December 31, 1998 and
1997, and the related consolidated statements of income, shareholders' equity
and comprehensive income, and cash flows for each of the years in the three-year
period ended December 31, 1998. These consolidated financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated financial statements based on our audits.

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

In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of
Community Financial Group, Inc. and subsidiary as of December 31, 1998 and 1997,
and the results of their operations and their cash flows for each of the years
in the three-year period ended December 31, 1998 in conformity with generally
accepted accounting principles.




/s/ KPMG LLP
Nashville, Tennessee
January 26, 1999



                                      -58-
<PAGE>   53


                 COMMUNITY FINANCIAL GROUP, INC. AND SUBSIDIARY
                                   (UNAUDITED)
                      CONSOLIDATED QUARTERLY FINANCIAL DATA



<TABLE>
<CAPTION>
                                                             1998
                                                      Three Months Ended
(In Thousands,
 except per share data)           December 31    September 30       June 30        March 31
--------------------------------------------------------------------------------------------
<S>                               <C>            <C>                <C>            <C>
Interest income                     $4,251          $4,162          $4,132          $4,046
Interest expense                     1,981           1,973           2,063           2,018
--------------------------------------------------------------------------------------------

Net interest income                  2,270           2,189           2,069           2,028

Provision for loan losses               25              25              39              39
Non-interest income                    572             578             359             296
Non-interest expense                 1,687           1,695           1,444           1,245
--------------------------------------------------------------------------------------------

Income before income taxes           1,130           1,047             945           1,040
Provision for income taxes             422             403             356             400
--------------------------------------------------------------------------------------------

Net income                          $  708          $  644          $  589          $  640
============================================================================================
Income per share:
    Basic                           $  .28          $  .26          $  .25          $  .29
    Diluted                            .17             .23             .17             .22
============================================================================================

Weighted Average Common
  Shares Outstanding
    Basic                            2,540           2,457           2,363           2,214
    Diluted                          4,250           2,754           3,414           2,867
============================================================================================
</TABLE>



                                      -59-
<PAGE>   54


                 COMMUNITY FINANCIAL GROUP, INC. AND SUBSIDIARY
                                   (UNAUDITED)
                      CONSOLIDATED QUARTERLY FINANCIAL DATA



<TABLE>
<CAPTION>
                                                            1997
                                                     Three Months Ended
(In Thousands,
  except per share data)         December 31     September 30      June 30         March 31
-------------------------------------------------------------------------------------------
<S>                              <C>             <C>               <C>             <C>
Interest income                     $4,006          $3,984          $3,821          $3,449
Interest expense                     2,107           2,084           1,984           1,781
-------------------------------------------------------------------------------------------

Net interest income                  1,899           1,900           1,837           1,668

Provision for loan losses               25              25              25              25
Non-interest income                    388             435             312             286
Non-interest expense                 1,186           1,309           1,309           1,432
-------------------------------------------------------------------------------------------

Income before income taxes           1,076           1,001             815             497
Provision for income taxes             439             420             277             195
-------------------------------------------------------------------------------------------

Net income                          $  637          $  581          $  538          $  302
===========================================================================================

Income per share:
    Basic                           $  .29          $  .26          $  .24          $  .14
    Diluted                            .25             .26             .24             .14
===========================================================================================

Weighted Average Common
  Shares Outstanding
    Basic                            2,207           2,205           2,204           2,203
    Diluted                          2,597           2,234           2,233           2,231
===========================================================================================
</TABLE>



                                      -60-
<PAGE>   55


                            COMMON STOCK INFORMATION


The common stock of Community Financial Group, Inc., is traded on Nasdaq Stock
Market(R) under the symbol CFGI. As of December 31, 1998, there were 466
shareholders of record of CFGI common stock.

The following table sets forth the Company's high and low prices during each
quarter for the past two years.

<TABLE>
<CAPTION>
                                                                   Market Price               Dividends
                      1998                                      High          Low
                  <S>                                         <C>            <C>                <C>
                  First quarter                               $15.00         $13.69             $.06
                  Second quarter                               17.06          14.00              .06
                  Third quarter                                15.00          12.06              .06
                  Fourth quarter                               12.88          11.81              .06

<CAPTION>
                                                                 Market Price                 Dividends
                      1997                                     High           Low
                  <S>                                         <C>            <C>                <C>
                  First quarter                               $12.75        $10.75              $.05
                  Second quarter                               12.25         11.00               .05
                  Third quarter                                12.13         11.25               .05
                  Fourth quarter                               15.13         11.75               .05
</TABLE>


Quarterly stock price quotations were provided by the Nasdaq Stock Market(R),
and reflect prices without retail markup, markdown or commissions and may not
reflect actual transactions.



                                      -61-