<PAGE>
 
                                   EXHIBIT 13
<PAGE>
 
To Our Shareholders:


The current economic climate is filled with speculation regarding consolidation
and diversification, as well as the continued lowering of interest rates.  I am
pleased to report that Citizens Federal has stayed on course and continued to
prosper during this atmosphere of intense competition.  Both our cash and
liquidity positions remain strong, and we realized net income of $218,950
despite recording a $176,000 loan loss provision for the year ended September
30, 1998.  Our capital and surplus well exceed the required regulatory levels
set by federal regulation.  Our net loans increased by $2,840,607 or 6.67% to
$45,413,484 for the year ended September 30, 1998.  Based on our healthy capital
and surplus, our directors declared a dividend to shareholders as of December
11, 1998 of $.75 per share.

Building on our corporate mission to provide quality service, while maintaining
our financial strength and stability, we implemented several initiatives, which
prepare us for the future.  Anticipating growth and development opportunities,
our board of directors voted to form CFS Bancshares, Inc.  This corporate
restructuring positions us to take advantage of increased flexibility in the
diversification of operations, while limiting the risks generally associated
with an interest rate-sensitive industry.

We also upgraded our technology to include a new product, telephone banking,
which will be implemented by the end of the second quarter of our next fiscal
year.  Our new computer system allows us the option to add other services, such
as computer banking, as we prepare our business for the next millennium.

As we approach the year 2000, we also focused on another crucial task  readying
our computer system for year 2000 compliance.  Our federal regulators require
that all modifications be in place and tested by March 31, 1999.  We have
implemented a plan which ensures that Citizens Federal and its vendors will test
their information systems and make changes to software as necessary to meet all
requirements.

The future should be not regarded as a single event, but as a process, charted
by forward thinking and sound planning.  With the loyal support of our
customers, we will continue to build today's plans for strong financial growth
and stability.  And through the hard work and performance of our efficient,
courteous, professional staff, we will continue to make improvements in customer
service, always providing the highest quality in financial services to our
banking friends.

Our new product campaign reflects Citizens Federal's sustained commitment and
our current goal to be more than you knew and everything you need in a bank.



                    Sincerely,


                    /s/ Bunny Stokes Jr.
                    Bunny Stokes, Jr.
                    Chairman of the Board and
                    Chief Executive Officer
<PAGE>
 
                             Financial Highlights
 
               (Dollars in thousands, except per share amounts)

<TABLE> 
<CAPTION>  
                                                     September 30,
                                                   
                                                1998               1997
          <S>                                 <C>                 <C> 
          Balance Sheets:                                                     
              Loans receivable, net           $45,413             42,573      
              Investment securities           $35,461             44,719      
              Interest bearing deposits       $73,892             76,346      
              FHLB advances                   $ 9,200              9,200      
              Stockholders' equity            $ 7,908              7,798      
              Book value per share            $ 60.83              59.98      
          Operations:                                                         
              Net income                      $   219                358      
              Earnings per share              $  1.72               2.75      
</TABLE> 
                                         
PROFILE

     CFS Bancshares, Inc. ("the Company") was organized by Citizens Federal
Savings Bank (Citizens Federal or the Bank) to be a savings and loan holding
company.  The Company was organized at the direction of the Bank in January 1998
to acquire all of the capital stock of the Bank upon the consummation of the
reorganization of the Bank into the holding company form of ownership, which was
completed on June 30, 1998.  The company's stock became registered under the
Securities Act of 1933 on June 30, 1998.  The company has no significant assets
other than the corporate stock of the Bank.  For that reason the discussion in
the annual report relates to the operations of the Bank.

     Citizens Federal Savings Bank was chartered by the Federal Home Loan Bank
Board, predecessor to the Office of Thrift Supervision (OTS), in September 1956
and has been in operation since that time.  The Bank is a member of the Federal
Deposit Insurance Corporation (FDIC), with its deposit accounts insured up to
applicable limits by the Savings Association Insurance Fund (SAIF), and of the
Federal Home Bank (FHLB).  On March 28, 1983 Citizens Federal's charter was
restated when it converted from a federal mutual savings and loan association to
a federal capital stock association through the sale and issuance of 130,000
shares of common stock.  On October 10, 1983 the Bank converted from a federal
stock savings and loan association to a federal stock savings bank.

     Citizens Federal's operations are conducted from its main office
headquarters located at 1700 3/rd/ Avenue North, Birmingham, Alabama and branch
offices at 2100 Bessemer Road, Birmingham, Alabama and 213 Main Street, Eutaw,
Alabama.  The Bank's primary business is the promotion of thrift through the
solicitation of savings accounts from its depositors and the general public, and
the promotion of home ownership through the granting of mortgage loans,
principally to finance the purchase and/or construction of residential dwellings
and to a lesser extent non-residential buildings located within its principal
lending area in Jefferson and Greene Counties, Alabama.

     At the present time, there is neither an established market in which shares
of the CFS Bancshares, Inc. capital stock are regularly traded nor any uniformly
quoted price for such shares.  During 1989, the Bank's board of directors
adopted an Employee Stock Ownership Plan (ESOP) for the benefit of the Bank's
employees.  As of September 30, 1998 the ESOP owned 30,765 shares or 23.66% of
the Company's outstanding common stock.

     Based on recent trades known to the Company, the price per share of the
Company's stock is approximately $18.50 per share. The Bank paid dividends of
$.75 per share in December 1997 and 1996, respectively. A cash dividend of $.75
per share was also declared by the board of directors of CFS Bancshares on
November 19, 1998 payable to all stockholders of record as of December 11, 1998.
As of December 11, 1998 the Bank had 337 stockholders.
<PAGE>
 
Selected Financial Data

(Dollars in thousands, except for share and per
share amounts)

<TABLE> 
<CAPTION> 
                                                                        At September 30,
                                                   ------------------------------------------------------------
                                                          1998        1997        1996        1995        1994
                                                          ----        ----        ----        ----        ----
<S>                                                    <C>         <C>         <C>         <C>         <C> 
BALANCE SHEETS
     Total assets                                       92,166      99,640      85,997      86,119      82,702
     Loans, net                                         45,413      42,573      30,532      28,611      27,418
     Investment securities                              35,461      44,718      41,611      43,152      48,654
     Deposits                                           73,892      76,346      76,793      76,754      74,040
     Borrowed funds                                      9,200       9,200           -           -           -
     Stockholders' equity                                7,908       7,798       7,312       7,751       7,488

Shares outstanding (actual number)                     130,000     130,000     130,000     130,000     130,000
     Book value per share                                60.83       59.98       56.25       59.62       57.60
</TABLE> 

<TABLE> 
<CAPTION> 
                                                                    Years ended September 30,
                                                   ------------------------------------------------------------
                                                          1998        1997        1996        1995        1994
                                                          ----        ----        ----        ----        ----
<S>                                                    <C>         <C>         <C>         <C>         <C> 
OPERATIONS
    Interest income                                      6,543       6,016       5,967       5,900       5,763
    Interest expense                                     3,525       3,127       3,169       2,993       2,538
    Net interest income                                  3,018       2,889       2,798       2,907       3,225
    Provision for loan loss                                176           -           -           -           -
    Net gains on securities                                 47         141           -         112          68
    Other noninterest income                               443         475         380         339         269
    SAIF special assessment expense                          -           -         494           -           -
    Other noninterest expense                            2,981       2,947       2,979       2,834       2,676
    Income (loss) before income taxes                      351         558        (295)        524         886
    Income tax benefit (expense)                          (132)       (200)        102        (189)       (319)
    Effect of accounting method change                       -           -           -           -         175
    Net income (loss)                                      219         358        (193)        335         742
                                                   ============================================================

PER SHARE INFORMATION
    Net income (loss) per share                           1.82        2.75       (1.49)       2.58        5.71
    Cash dividends declared                               0.75        0.75        0.75        0.75        0.75
    Average shares outstanding                         120,407     130,000     130,000     130,000     130,000
</TABLE> 

<TABLE> 
<CAPTION> 
                                                             At or for the years ended September 30,
                                                   ------------------------------------------------------------
                                                          1998        1997        1996        1995        1994
                                                          ----        ----        ----        ----        ----
<S>                                                     <C>         <C>         <C>         <C>         <C> 
OTHER DATA
    Average yield on interest earning assets             7.50%       7.63%       7.49%       7.42%       7.37%
    Average rate on deposits and borrowed funds          4.11%       4.01%       4.14%       3.98%       3.47%
    Interest rate spread                                 3.39%       3.62%       3.35%       3.44%       3.90%
    Return on average assets                             0.23%       0.42%      -0.22%       0.40%       0.92%
    Return on average stockholders' equity               2.77%       4.80%      -2.56%       4.40%      10.38%
    Equity to assets ratio                               8.58%       7.83%       8.50%       9.00%       9.05%
    Dividend payout ratio                               44.53%      27.23%       n/a        29.07%      13.13%
</TABLE> 
<PAGE>
 
Management's Discussion and Analysis

     At September 30, 1998 the Bank's total assets were $92,166,042 as compared
to $99,640,318 at September 30, 1997, a decrease of $7,474,276 or 7.50%.  The
decrease in total assets is largely attributable to a significant decrease in
the Bank's investment portfolio.  At September 30, 1998 the Bank's investment
portfolio included securities available for sale of $29,122,737 and securities
held to maturity of $6,338,130 as compared to $35,915,192 and $8,803,393,
respectively at September 30, 1997 a decrease of $6,792,455 and $2,465,263,
respectively.  The Bank purchased and recorded several investment securities
totaling $4,975,130 during September 1997, which did not settle until October
1997 during the current fiscal year.  The payable for investment securities was
satisfied during the first month of the current fiscal year with proceeds from
federal funds sold and overnight deposits and a security which was called during
October 1997.  There was no such transaction during the final month of the
fiscal year ended September 30, 1998.  Declines in the portfolio also resulted
from significant principal payments on mortgage-backed securities and CMOs and
from calls of investment securities.  The excess cash flow from the portfolio
was used to fund increases in the Bank's loan portfolio and net deposit
withdrawals.   Net loans increased from $42,572,877 at September 30, 1997 to
$45,413,484 at September 30, 1998 an increase of $2,840,607 or 6.67%.  The
Bank's primary emphasis continues to be mortgage lending as 8.52 million or
88.46% of the 9.63 million in loans granted during the year were mortgage loans.

     Deposits totaled $73,892,189 at September 30, 1998 compared to $76,345,726
at September 30, 1997, a decrease of $2,453,537 or 3.21%.  Deposit declines
occurred in the Bank's transaction accounts which consist of passbook savings
accounts and NOW accounts.  Borrowings at September 30, 1998 remained unchanged
from the balance at September 30, 1997 of  $9,200,000 as the Bank maintained its
level of borrowing from the Federal Home Loan Bank of Atlanta.  The Bank's one
to four family residential mortgage portfolio serves as collateral for the FHLB
advances.

     Non-performing assets, which included non-accrual loans and real estate
acquired by foreclosure (REO) increased $398,513 or 62.70% from $635,595 at
September 30, 1997 to $1,034,108 at September 30, 1998 as non-accrual loans
increased from $536,101 at September 30, 1997 to $974,474 at September 30, 1998
and REO declined $39,860 from $99,494 at September 30, 1997 to $59,364 at
September 30, 1998.  Due to the increase in the number and amount of non-
performing loans management recorded through earnings an addition of $176,000 to
the provision for loan losses.  At September 30, 1998 non-performing assets
represented 1.12% of total assets while non-accrual loans represented 2.07% of
gross loans outstanding, each of which represents an increase from September 30,
1997 when non-performing assets represented .63% of total assets while non-
accrual loans were 1.21% of gross loans outstanding.

     Interest rate levels, the health of the economy (particularly the real
estate economy), securities transactions and the amount of non-performing assets
affect the Bank's financial condition and results of operations.
<PAGE>
 
<TABLE>
<CAPTION>
(Dollars in thousands)                                                   Years ended September 30,
                                             ---------------------------------------------------------------------------------
                                                         1998                        1997                       1996
                                                 Average       Yield or      Average      Yield or      Average      Yield or
                                               ------------  ------------  -----------  ------------  -----------  ------------
                                                 Balance         Rate        Balance        Rate        Balance        Rate
                                               ------------  ------------  -----------  ------------  -----------  ------------
<S>                                            <C>           <C>           <C>          <C>           <C>          <C>
ASSETS
Federal funds and interest
  Bearing deposits                                   3,406          5.57%       2,855          5.37%       6,683          5.98%
Investments securities
  held to maturity (1)                               8,187          6.39%      12,027          6.53%      19,371          6.27%
Investment securities
  Available for sale                                31,180          5.90%      28,791          6.28%      23,394          6.49%
Loans, net (2)                                      44,920          8.88%      35,799          9.13%      30,221
                                               -----------                -----------                -----------
  Total interest earning assets                     87,693          7.50%      79,472          7.57%      79,669          7.49%
Loan loss allowances                                  (447)                      (634)                      (649)
Non-interest earnings assets                         7,711                      7,862                      7,038
                                               -----------                -----------                -----------
    Total assets                                    94,957                     86,700                     86,058
                                               ===========                ===========                ===========
 
LIABILITIES AND STOCKHOLDERS' EQUITY
Interest bearing deposits                           75,374          3.90%      76,577          4.00%      76,630          4.14%
FHLB advances                                        9,913          5.93        1,098          5.89%           -             -
                                               -----------                -----------                -----------
  Total interest bearing liabilities                85,287          4.13%      77,675          4.03%      76,630          4.14%
Accrued interest on deposits                           287                        309                        144
Other liabilities                                    1,481                      1,251                      1,751
Stockholders' equity                                 7,902                      7,465                      7,533
                                               -----------                -----------                -----------
    Total liabilities and stockholders'             94,957                     86,700                     86,058
     equity
                                               ===========                ===========                ===========
 
Interest rate spread                                                3.37%                      3.54%                      3.35%
                                                            ============               ============               ============
Net interest margin (3)                                             3.44%                      3.63%                      3.51%
                                                            ============               ============               ============
</TABLE> 
 
(1) Includes Federal Home Loan Bank stock
(2) Loan yields calculated using average balance of gross loans
(3) Net interest income before loan loss provision divided by total average
    interest earning assets

<PAGE>
 
Comparison of years ended September 30, 1998 and September 30, 1997

GENERAL

     Net income for the year ended September 30, 1998 was $218,950 compared to
$358,134 for the year ended September 30, 1997 a decrease of $139,364.  The
decrease is the result of a provision for loan losses recorded for the year
ended September 30, 1998 in the amount of $176,000 compared to no loan loss
provision for the year ended September 30, 1997.  The Bank's operating results
depend largely upon its net interest margin which is the difference between the
income earned on loans and investments, and the interest expense paid on
deposits and borrowings, divided by average total interest earning assets.  The
net interest margin is affected by the economic and market factors which
influence interest rates, loan demand and deposit flows.  The interest rate
margin decreased from 3.63% for the year ended September 30, 1997 to 3.49% for
year ended September 30, 1998.

INTEREST INCOME

     Net interest income before provision for loan losses increased by $129,554
or 4.48% to $3,018,202 for the year ended September 30, 1998 from $2,888,648 for
the year ended September 30, 1997 as a result of an increase in average interest
earning assets from fiscal 1997 to fiscal 1998 of approximately $8,257,000.
Interest and fees on loans increased by $720,466 or 22.03% as the average
balance of loans outstanding increased from $35,799,000 for the year ended
September 30, 1997 to $44,920,000 for the current fiscal year.  The increase in
interest and fees on loans was tempered by a decline in the average yield on
loans of 25 basis points from 9.13% for the year ended September 30, 1997 to
8.88% for the year ended September 30, 1998.  The increase in interest and fees
on loans was partially offset by declines in interest earned on federal funds,
interest bearing deposits and investment securities which resulted from a
decline in the average yield earned on those investments as well as a modest
decrease in the average outstanding balance between the year ended September 30,
1997 and the current fiscal year.  The average yield on interest earning assets
other than loans declined by 32 basis points from 6.29% for the year ended
September 30, 1997 to 5.97% for the current fiscal year while the average
balance outstanding declined approximately $900,000 when comparing the year
ended September 30, 1998 to the prior fiscal year.

INTEREST EXPENSE

     Total interest expense increased by $397,898 or 12.72% to $3,524,799 for
the year ended September 30, 1998 from $3,126,901 for the year ended September
30, 1997 as the average balance of interest bearing liabilities increased by
$7,612,000 from $77,675,000 for the year ended September 30, 1997 to $85,287,000
for the current fiscal year.  The increase in liabilities relates to FHLB
advances which were acquired during the final three months of the prior fiscal
year and remained outstanding throughout the current fiscal year.  The average
rate on interest bearing liabilities increased 10 basis points from 4.13% for
the year ended September 30, 1997 to 4.03% for the current fiscal year as the
higher rate FHLB advances made up a larger percentage of the average balance of
liabilities outstanding during the current fiscal year.

OTHER INCOME

     Total other income decreased $126,172 or 20.48% for the year ended
September 30, 1998 compared to the 1997 period.  The decline was primarily the
result of a decrease in gains on sale of investment securities from $140,829 for
the year ended September 30, 1997 to $46,594 for the current fiscal year along
with a $27,835 decline in service charges on deposit accounts from $432,581 for
the 1997 fiscal year to $404,746 for the year ended September 30, 1998.  The
decline is primarily the result of decreases in the Bank's transaction accounts.

OTHER EXPENSE

     Total other expense consists of salaries and employee benefits, occupancy
and equipment,  FDIC deposit insurance, data processing expense, legal and
professional services, advertising and other expenses.  The costs of carrying
and administering non-performing assets is also included in other expense.
Other expenses remained at approximately the same level increasing by $35,023 or
1.19% from $2,946,533 for the year ended September 30, 1997 to $2,981,556 for
the year ended September 30, 1998.  With the exception of data processing
expense and professional services all categories of other expense remained at
the same level as last year or declined.  During fiscal 1998 the Bank changed to
a new data processing system and incurred additional expense related to the
conversion to the new system.  Data processing expense increased by $18,513 or
8.89% when comparing the results of the current fiscal year to the year 
<PAGE>
 
ended September 30, 1997. Professional services increased by $91,257 or 68.14%
from $133,917 for the year ended September 30, 1997 to $226,734 for the current
fiscal year. During the year the Bank reorganized into the holding company form
of ownership and incurred additional legal and accounting expense. The Bank also
hired a consultant during the year ended September 30, 1998 to assist the Bank
in meeting its obligations in complying with various regulatory rules and
requirements.

Comparison of years ended September 30, 1997 and September 30, 1996

GENERAL

     Net income for the year ended September 30, 1997 amounted to $358,134
compared with a net loss of $193,382 for the year ended September 30, 1996 an
increase of $551,516.  The principal reasons for the increased net interest
income and other income and decreased other expense (non-interest expense).  The
Bank's operating results depend largely upon its net interest margin which is
the difference between the income earned on loans and investments, and the
interest expense paid on deposits and borrowings, divided by average total
interest earning assets.  The net interest margin is affected by the economic
and market factors which influence interest rates, loan demand and deposit
flows.  The interest rate margin increased from 3.49% for the year ended
September 30, 1996 to 3.63% for the year ended September 30, 1997.

INTEREST INCOME

     Net interest income increased by $90,347 or 3.23% to $2,888,648 for the
year ended September 30, 1997 when compared to the year ended September 30, 1996
though the average balance of interest earning assets remained essentially the
same during the two periods.  Interest and fees on loan increased $411,653 or
14.40% as a result of an increase in the average balance of net loans
outstanding of $5,088,000 or 16.92% from $30,077,000 for the year ended
September 30, 1996 to an average outstanding balance of $35,165,000 for the year
ended September 30, 1997.  The increase in interest and fees on loans was
tempered by a decline in the average yield on loans of 17 basis points from
9.30% for the year ended September 30, 1996 to 9.13% for the year ended
September 30, 1997.  Higher interest and fees on loans was partially offset by
declines in interest earned on federal funds sold and interest bearing deposits
(short term investments) and investment securities which resulted both from a
decline in the average balance outstanding as well as a decline in the average
yield earned on those investments.  The average outstanding balance of short
term investments and investment securities declined by approximately $3,828,000
and $1,947,000, respectively between the years ended September 30, 1996 and
September 30, 1997 as the proceeds from those assets were used to fund growth in
the Bank's loan portfolio and to pay for the construction of the Bank's new home
office.  The average yield earned on short term investments declined from 5.98%
for the year ended September 30, 1996 to 5.36% for the year ended September 30,
1997 while the yield earned on investment securities declined only slightly
between fiscal 1996 and fiscal 1997.

INTEREST EXPENSE

     Total interest expense decreased by $42,018 or 1.33% to $3,126,901 for the
year ended September 30, 1997 from $3,168,919 for the year ended September 30,
1996.  Interest on deposits declined by $106,732 or 3.37% as the average cost of
deposits declined from 4.14% for the year ended September 30, 1996 to 4.00% for
the year ended September 30, 1997.  During the final three months of the fiscal
year ended September 30, 1997 the Bank acquired $9,200,000 in advances from the
Federal Home Loan Bank of Atlanta which had an average rate of 5.89% during the
year ended September 30, 1997.


OTHER INCOME

     Total other income increased $235,884 or 62.02% for the year ended
September 30, 1997 compared to the prior fiscal year.  The increase was mainly
the result of increases in service charges on deposit accounts and gains on the
sale of investment securities.  The increase in service charges resulted from
overall increases in and the addition of fees on deposits accounts the Bank
provides to its customers.  The gain on sale of securities was due to favorable
market interest rate during the year and includes approximately $54,000 in
recoveries of losses on securities which had been previously written down
through the statement of operations in the 1994 fiscal year end prior, to the
Bank's adoption of Financial Accounting Standard 115.
<PAGE>
 
OTHER EXPENSE

     Total other expense consists of salaries and employee benefits, occupancy
and equipment expense, FDIC deposit insurance, data processing expense, legal
and professional services, advertising expense and other expenses.  Other
expense decreased for the year ended September 30, 1997 by $527,012 or 15.17%
when compared to the year ended September 30, 1996.  The primary reason for the
decline relates to the special assessment by the FDIC to capitalize the SAIF
insurance fund which amounted to $493,687 for Citizens Federal and is included
in federal insurance premiums for the year ended September 30, 1996.  Other
changes between fiscal year 1996 and 1997 included increases in salaries and
employee benefits and advertising expense of $123,499 and $81,972, respectively
and decreases in professional services of $75,950 and other expenses of $61,745.
The increase in salary expense and advertising expense relate primarily to the
Bank's lending function as additional staff was added to the loan department and
the Bank's advertising was increased in an effort to increase the number and
amount of loans in the Bank's loan portfolio.  There were also changes in net
occupancy expense and depreciation and amortization which relate to the Bank's
move to a new main office in October 1996.  Net occupancy expense declined by
$136,674 and depreciation expense increased $133,540 between fiscal 1996 and
1997 as the Bank discontinued lease payments on its previous headquarters and
began depreciating the cost of the new main office which is wholly owned and
occupied by Citizens Federal.

LIQUIDITY AND CAPITAL RESOURCES

     The holding company's primary source of liquidity is dividends  from the
Bank.  The Bank's primary sources of liquidity are deposits, loan payments,
maturing investment securities, principal and interest payments on investments,
mortgage-backed securities and CMOs, and advances from the Federal Home Loan
Bank of Atlanta.  Management believes it is prudent to maintain an investment
portfolio that not only provides a source of income, but also provides a source
of liquidity through its principal payments and maturities to meet lending
demands and fluctuations in deposit flows.  The various sources of liquidity are
utilized to fund withdrawals, new loans and other investments, as well as to pay
expenses of operations.  Management believes that the Bank's various sources of
funds are adequate to meet its commitments in the ordinary course of business.
The Bank is required under applicable federal regulations to maintain specified
levels of cash and liquid investments equal to a required percentage of net
withdrawable deposit accounts.  The Bank exceeded all regulatory liquidity
requirements during the years ended September 30, 1998 and 1997.

     Quantitative measures established by regulations to ensure capital adequacy
require the Bank to maintain minimum amounts and ratios (set forth in the table
below) of total and Tier I capital to risk-weighted assets, and of Tier I
capital to average assets.  Management believes, as of September 30, 1998, that
the Bank meets all capital adequacy requirements and meets the requirements to
be classified as "well capitalized."

<TABLE>
<CAPTION>
                                                                        FOR CAPITAL                       WELL
                                            ACTUAL                   ADEQUACY PURPOSES                CAPITALIZED
                                     Amount        Ratio             Amount       Ratio           Amount        Ratio
<S>                                 <C>            <C>             <C>            <C>             <C>           <C> 
AS OF SEPTEMBER 30, 1998:

Total capital
   (to risk weighted assets)        $8,272,808     18.25%          $3,626,080     8.00%         $4,532,600       10.00%
                                                                                           
Tier I capital                                                                             
   (to risk weighted assets)        $7,900,450     17.43%          $1,813,040     4.00%         $2,719,560        6.00%
                                                                                           
Tier I capital                                                                             
   (to average assets)              $7,900,450      8.32%          $3,798,280     4.00%         $4,747,850        5.00%

</TABLE>
<PAGE>
 
Impact of Inflation and Changing Prices

     The financial statements and related financial data presented herein have
been prepared in accordance with generally accepted accounting principles which
require the measurement of financial position and operating results in terms of
historical dollars, without considering changes in relative purchasing power
over time due to inflation.  Unlike most industrial companies, virtually all the
assets and liabilities of the thrift institution are monetary in nature.  As a
result, interest rates generally have a more significant impact on a financial
institution's performance than does the effect of inflation.  Because the Bank's
primary assets are loans and investment securities, which include more fixed
rate, fixed term loans and securities than adjustable rate loans and
investments, changes in interest rates in the economy have a gradual impact on
yield on assets.  The Bank's principal liability is deposit accounts, which are
primarily short term in nature and, therefore, adjust rapidly with changes in
the economy.  In general, periods of high inflation are accompanied by high
interest rates.  When rates move up rapidly, the Bank's cost of funds increases
rapidly while the yield on its assets increases slowly, resulting in a negative
impact on net income.  Conversely, during periods of low inflation lower and
more moderate interest rates are normally present, which results in a low cost
of funds and a more favorable impact on net income.

Contingencies and Commitments

     The Bank is defending various claims arising out of the conduct of its
business.  While the ultimate results of these claims cannot be predicted with
the certainty, in the opinion of management, the ultimate disposition of these
matters will not have a significant effect on the consolidated financial
position of the Company.

     Effective October 18, 1996 and July 23, 1998, the Bank entered into
Agreements with the Office of Thrift Supervision (OTS) intended to correct
certain deficiencies, about which the OTS expressed supervisory concern.
Pursuant to the Agreements, the Bank agreed to adopt certain guidelines,
procedures and policies.  The Bank also agreed to adopt a business plan covering
such matters as lending activities, operating expenses, operating results and
other matters.

     The Bank believes it is in substantial compliance with or will be in
compliance with the terms of the Agreements within the time periods stated
within the agreements.  If the Bank were not to comply with the Agreements, the
OTS would have certain enforcement rights, possibly including the right to
commence an action to remove directors and/or officers or to appoint a
conservator or a receiver for the Bank.  Although compliance with the Agreements
has not had and is not expected to have a material impact on the operations of
the Bank, there can be no assurance that Agreements will not have an adverse
impact on the Bank's future operations.


Year 2000 Issues

     The Bank is a user of computers, computer software and equipment utilizing
embedded microprocessors that are affected by the year 2000 issue.  The year
2000 issue exists because many computer systems and application use two digit
date fields to designate a year.  As the century date change occurs, date
sensitive systems may recognize the year 2000 as 1900, or not at all.  The
inability to recognize or properly treat the year 2000 may cause erroneous
results, ranging from system malfunctions to incorrect or incomplete processing.

     Citizens Federal Savings Bank has prepared an action plan to evaluate our
computer systems, software products and vendor services for year 2000
compliance.  The Bank's plan consists of the following:

     PROBLEM AWARENESS - The Bank is aware of the problems that could
     potentially arise from year 2000 problems and has analyzed internal systems
     as well as services provided by third parties.  Educational initiatives
     with regard to customer awareness will continue into 1999.

     ASSESSMENT PHASE - The Bank has inventoried technology assets and contacted
     third party vendors and service providers to assess exposure to year 2000
     problems.  The Bank's third party data processing arrangement has been
     identified as the primary mission critical system for Citizens Federal.

     RENOVATION PHASE - Hardware and software which was identified during the
     assessment phase as not being year 2000 compliant has been upgraded,
     replaced or scheduled for replacement during the early part of 1999.  A
     third party processor provides the Bank's data processing and one set of
<PAGE>
 
     testing was done between the Bank and the processor during September 1998.
     Based on the results from testing which has already been conducted the
     mission critical third party data processing system will be ready for year
     2000 processing.


     VALIDATION - The Bank's internal systems as well as the third party
     processor which provides the Bank's primary data processing requirements
     have been tested for year 2000 compliance.  Additional testing of those
     critical applications is scheduled for the early part of 1999.  In addition
     to the testing conducted by Citizens Federal with the third party
     processor, only 100 other users of the system have also conducted tests and
     will be doing additional testing for year 2000 readiness.  The Bank has
     received certifications from other vendors and service providers and will
     rely on those where complete testing is not possible.

     IMPLEMENTATION  Replacement of non-compliant technology at the institution
     is essentially complete.  Results from additional tests, which are
     scheduled for early 1999, will be thoroughly reviewed and remedial actions,
     which are determined to be necessary for year 2000 compliance, will be
     taken.

     During the year ended September 30, 1998 the Bank incurred approximately
$15,000 in capital expenditures to upgrade and replace computer equipment and
approximately $5,000 in operating expenses associated with year 2000 compliance.
Additional expenditures to attain year 2000 readiness are not expected to have a
material financial impact on the Bank.


Information About Forward-Looking Statements

     Any statement contained in this report which is not a historical fact, or
which might otherwise be considered an opinion or projection concerning the Bank
or its business, whether expressed or implied, is meant as and should be
considered a forward-looking statement as that term is defined in the Private
Securities Litigation Reform Act of 1996.  Forward-looking statements are based
on assumptions and opinions concerning a variety of known and unknown risks,
including but not necessarily limited to changes in market conditions, natural
disasters and other catastrophic events, increased competition, changes in
availability and cost of reinsurance, changes in governmental regulations, and
general economic conditions, as well as other risks more completely described in
the Bank's filings with the Securities and Exchange Commission, including this
Annual Report on Form 10-KSB.  If any of these assumptions or opinions prove
incorrect, any forward-looking statements made on the basis of such assumptions
or opinions may also prove materially incorrect in one or more respects.
<PAGE>
 
[LETTERHEAD OF KPMG PEAT MARWICK LLP APPEARS HERE]


                         INDEPENDENT AUDITORS' REPORT


The Stockholders and Board of Directors
CFS Bancshares, Inc. and Subsidiaries:


We have audited the accompanying consolidated balance sheets of CFS Bancshares,
Inc. and subsidiaries  (the Company) as of September 30, 1998 and 1997 and the
related consolidated statements of operations, stockholders' equity, and cash
flows for each of the years in the three-year period ended September 30, 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 financial position of CFS Bancshares, Inc.
and subsidiaries as of September 30, 1998 and 1997, and the results of their
operations and their cash flows for each of the years in the three-year period
ended September 30, 1998, in conformity with generally accepted accounting
principles.


                                                       /s/ KPMG Peat Marwick LLP

November 6, 1998
<PAGE>
 
                             CFS BANCSHARES, INC.
                               AND SUBSIDIARIES

                          Consolidated Balance Sheets

                          September 30, 1998 and 1997

<TABLE> 
<CAPTION> 
                                        ASSETS                                         1998                 1997
                                                                                   ------------         ------------
<S>                                                                                <C>                  <C> 
Cash and amounts due from depository institutions                                  $  3,392,435            2,963,847
Federal funds sold and overnight deposits                                             1,924,850            3,521,268
                                                                                   ------------         ------------
         Total cash and cash equivalents                                              5,317,285            6,485,115

Interest-earning deposits in other financial institutions                               159,515              157,574
Investment securities held to maturity (fair value of
    $6,406,439 and $8,826,498, respectively)                                          6,338,130            8,803,393
Investment securities available for sale, at fair value (cost of
    $29,110,859 and $35,872,942, respectively)                                       29,122,737           35,915,192
Federal Home Loan Bank stock                                                            670,000              460,000
Loans receivable, net                                                                45,413,484           42,572,877
Premises and equipment, net                                                           4,030,996            4,202,944
Real estate acquired by foreclosure, net                                                 59,634               99,494
Accrued interest receivable on investment securities                                     71,252               63,367
Accrued interest receivable on mortgage-backed securities                               217,817              163,779
Accrued interest receivable on loans                                                    352,244              412,654
Other assets                                                                            412,948              303,929
                                                                                   ------------         ------------
         Total assets                                                              $ 92,166,042           99,640,318
                                                                                   ============         ============

                    LIABILITIES AND STOCKHOLDERS' EQUITY

Liabilities:
    Interest-bearing deposits                                                      $ 73,892,189           76,345,726
    Advance payments by borrowers for taxes and insurance                               300,648              324,174
    Other liabilities                                                                   719,682              866,479
    Employee stock ownership plan debt                                                  145,471              130,941
    FHLB advances                                                                     9,200,000            9,200,000
    Payables for investment securities transactions                                          --            4,975,130
                                                                                   ------------         ------------
         Total liabilities                                                           84,257,990           91,842,450

Stockholders' equity:
    Serial preferred stock; 300,000 shares authorized;
       none outstanding                                                                      --                   --
    Common stock of $1 par value; 700,000 shares authorized;
       130,000 shares issued and outstanding                                            130,000              130,000
    Additional paid-in capital                                                        1,167,160            1,160,760
    Retained earnings-substantially restricted                                        6,732,461            6,611,011
    Unrealized gain on investment securities
       available for sale, net of taxes                                                   7,602               27,038
    Unearned common stock held by ESOP                                                 (129,171)            (130,941)
                                                                                   ------------         ------------
         Total stockholders' equity                                                   7,908,052            7,797,868
                                                                                   ------------         ------------ 
Commitments and contingencies (notes 12 and 13)
                                                                                   ------------         ------------
         Total liabilities and stockholders' equity                                $ 92,166,042           99,640,318
                                                                                   ============         ============
</TABLE> 

See accompanying notes to consolidated financial statements.

                                       2

<PAGE>
 
                             CFS BANCSHARES, INC.
                               AND SUBSIDIARIES

                     Consolidated Statements of Operations

                Years Ended September 30, 1998, 1997, and 1996

<TABLE>
<CAPTION>
                                                                   1998                1997                1996
                                                             -----------------   -----------------   -----------------
<S>                                                          <C>                 <C>                 <C> 
Interest income:
    Interest and fees on loans                               $      3,990,297           3,269,831           2,858,178
    Interest and dividend income on
       investment securities                                          478,512             942,405             988,589
    Interest income on mortgage-backed securities                   1,884,643           1,650,126           1,736,021
    Interest income on federal funds sold                             112,612              99,006             245,312
    Other interest income                                              76,937              54,181             139,120
                                                             -----------------   -----------------   -----------------
              Total interest income                                 6,543,001           6,015,549           5,967,220
Interest expense:
    Interest on deposits                                            2,937,155           3,062,187           3,168,919
    Interest on FHLB advances                                         587,644              64,714              --
                                                             -----------------   -----------------   -----------------
              Total interest expense                                3,524,799           3,126,901           3,168,919
              Net interest income                                   3,018,202           2,888,648           2,798,301
Provision for loan losses                                             176,000              --                  --
                                                             -----------------   -----------------   -----------------
              Net interest income after provision
                 for loan losses                                    2,842,202           2,888,648           2,798,301
Other income:
    Service charges on deposit accounts                               404,746             432,581             309,433
    Gains on sales of investment securities                            46,594             140,829              --
    Other                                                              38,699              42,801              70,894
                                                             -----------------   -----------------   -----------------
              Total other income                                      490,039             616,211             380,327

Other expense:
    Salaries and employee benefits                                  1,330,058           1,331,028           1,207,529
    Net occupancy expense                                             128,439             128,943             265,617
    Federal insurance premiums                                        100,106             117,915             696,120
    Data processing expenses                                          226,734             208,221             219,561
    Professional services                                             225,174             133,917             209,867
    Depreciation and amortization                                     277,258             295,374             161,834
    Advertising expense                                               137,931             150,545              68,573
    Office supplies                                                    67,759              78,989              74,375
    Insurance expense                                                  60,509              60,337              67,060
    Other                                                             427,588             441,264             503,009
                                                             -----------------   -----------------   -----------------
              Total other expense                                   2,981,556           2,946,533           3,473,545
                                                             -----------------   -----------------   -----------------
              Income (loss) before income taxes                       350,685             558,326            (294,917)
Income tax expense (benefit)                                          131,735             200,192            (101,535)
                                                             -----------------   -----------------   -----------------
              Net income (loss)                              $        218,950             358,134            (193,382)
                                                             =================   =================   =================
Basic earnings (loss) per share                              $           1.72                2.75               (1.49)
                                                             =================   =================   =================
Basic weighted average shares outstanding                             127,218             130,000             130,000
                                                             =================   =================   =================
Diluted earnings (loss) per share                            $           1.57                2.75               (1.49)
                                                             =================   =================   =================
Diluted weighted average shares outstanding                           139,218             130,000             130,000
                                                             =================   =================   =================
</TABLE> 

See accompanying notes to consolidated financial statements.

                                       3

<PAGE>
 
                             CFS BANCSHARES, INC.
                               AND SUBSIDIARIES
 
                Consolidated Statements of Stockholders' Equity
 
                Years Ended September 30, 1998, 1997, and 1996
 
<TABLE>
<CAPTION>
                                                                                        UNREALIZED
                                                                                      GAIN (LOSS) ON
                                                                       RETAINED         INVESTMENT     EMPLOYEE
                                                       ADDITIONAL     EARNINGS -        SECURITIES      STOCK           TOTAL
                                           COMMON       PAID-IN      SUBSTANTIALLY      AVAILABLE     OWNERSHIP     STOCKHOLDERS'
                                            STOCK       CAPITAL       RESTRICTED         FOR SALE     PLAN DEBT        EQUITY
                                          ---------    ----------    -------------    -----------    ----------     --------------
<S>                                      <C>           <C>           <C>              <C>             <C>           <C>
Balance September 30, 1995               $  130,000     1,160,760        6,641,259         80,640      (261,881)         7,750,778
                                          
Net loss                                         --            --         (193,382)            --            --           (193,382)
                                          
Payment of Employee Stock                 
  Ownership Plan debt                            --            --               --             --        65,470             65,470
                                          
Change in unrealized loss on
  investment securities available
  for sale, net                                  --            --               --       (213,081)           --           (213,081)
 
Cash dividends declared
  ($.75 per share)                               --            --          (97,500)            --            --            (97,500)
                                          ---------    ----------    -------------    -----------    ----------     --------------
Balance September 30, 1996                  130,000     1,160,760        6,350,377       (132,441)     (196,411)         7,312,285
 
Net income                                       --            --          358,134             --            --            358,134
 
Payment of Employee Stock
  Ownership Plan debt                            --            --               --             --        65,470             65,470
                                      
Change in unrealized gain on
  investment securities available
  for sale, net                                  --            --               --        159,479            --            159,479
 
Cash dividends declared
  ($.75 per share)                               --            --          (97,500)            --            --            (97,500)
                                          ---------    ----------    -------------    -----------    ----------     --------------
Balance September 30, 1997                  130,000     1,160,760        6,611,011         27,038      (130,941)         7,797,868
 
Net income                                       --            --          218,950             --            --            218,950
 
Change in unrealized gain
  on investment securities
  available for sale, net                        --            --               --        (19,436)           --            (19,436)
                                      
Employee Stock Ownership Plan
  shares allocated                               --         6,400               --             --        16,300             22,700

Acquisition of Employee Stock
  Ownership Plan shares                          --            --               --             --       (80,000)           (80,000)
                                      
Payment of Employee Stock
  Ownership Plan debt                            --            --               --             --        65,470             65,470
                                      
Cash dividends declared
  ($.75 per share)                               --            --          (97,500)            --            --            (97,500)
                                          ---------    ----------    -------------   ------------    -----------    --------------
Balance September 30, 1998               $  130,000     1,167,160        6,732,461          7,602      (129,171)         7,908,052
                                          =========    ==========    =============   ============    ===========    ==============
</TABLE> 
 
See accompanying notes to consolidated financial statements.

                                       4
<PAGE>
 
                             CFS BANCSHARES, INC.
                               AND SUBSIDIARIES

                     Consolidated Statements of Cash Flows

                Years Ended September 30, 1998, 1997, and 1996

<TABLE> 
<CAPTION> 
                                                                                1998              1997             1996
                                                                             ----------        ----------       ----------
<S>                                                                          <C>               <C>              <C> 
Cash flows from operating activities 
Net income (loss)                                                            $  218,950           358,134         (193,382)
Adjustments to reconcile net income (loss) to net
   cash provided by operating activities:
      Provision for loan losses                                                 176,000                --               --
      Depreciation and amortization                                             277,258           295,374          161,834
      Net amortization of premium and accretion of
        discount on investment securities                                        85,517            11,385           27,423
      Net accretion of discount on loans                                        (78,356)          (15,376)          (2,296)
      Compensation expense recognized on ESOP shares
        allocation                                                               85,700                --               --
      Gains on sale of investment securities available
        for sale, net                                                           (43,717)         (140,829)              --
      Gain on calls of investment securities
        available for sale, net                                                  (2,877)               --               --
      Loss on sale of real estate acquired by foreclosure                         4,243            19,001            1,549
      Loss on disposal of equipment                                                  --               390               --
      Charge-off of investment security held to maturity                         25,000                --               --
      (Increase) decrease in accrued interest receivable                         (1,513)           (4,619)         (37,923)
      (Increase) decrease in other assets                                       (98,083)          115,793         (139,834)
      (Increase) decrease in  refundable income tax                                  --                --          106,894
      Increase (decrease) in other liabilities                                 (146,797)         (486,849)         478,379
      Increase (decrease) in accrued interest on deposits                       (24,394)           41,173          (60,155)
                                                                             ----------        ----------       ----------
          Net cash provided by operating activities                             476,931           193,577          342,489
                                                                             ----------        ----------       ----------
</TABLE> 

                                                                     (Continued)

                                       5
<PAGE>
 
                             CFS BANCSHARES, INC.
                               AND SUBSIDIARIES

                     Consolidated Statements of Cash Flows

                Years Ended September 30, 1998, 1997, and 1996

<TABLE> 
<CAPTION> 
                                                                                 1998              1997              1996
                                                                             ------------      ------------      ------------
<S>                                                                          <C>               <C>               <C> 
Cash flows from investing activities:
   Net (increase) decrease in interest-earning deposits in
      other financial institutions                                                 (1,941)           98,117            (3,573)
   Proceeds from maturities or calls of
      investment securities held to maturity                                           --         3,000,000                --
   Purchases of investment securities held to maturity                                 --        (1,470,643)       (3,004,013)
   Proceeds from principal collected on mortgage-
      backed securities held to maturity                                        2,418,154         2,701,576         2,624,701
   Proceeds from sales of investment securities
      available for sale                                                        5,890,772         7,119,866                --
   Proceeds from maturities or calls of investment
      securities available for sale                                             5,692,097         3,000,000         2,500,000
   Purchases of investment securities available for sale                       (1,135,691)       (6,567,938)       (1,037,515)
   Purchases of mortgage-backed securities available for sale                 (16,330,001)       (7,911,562)       (1,256,849)
   Proceeds from principal collected on mortgage-backed
      securities available for sale                                             7,652,962         2,297,985         1,354,427
   Purchase of FHLB stock                                                        (210,000)               --                --
   Net change in loans                                                         (2,938,251)      (12,178,490)       (2,110,651)
   Purchase of premises and equipment                                            (105,310)         (697,741)       (2,035,474)
   Proceeds from sale of real estate acquired by foreclosure                      121,305           121,565           122,591
   Improvements to real estate acquired by foreclosure                               (399)          (15,622)               --
   Purchase of real estate acquired by foreclosure                                (85,289)               --                -- 
                                                                             ------------      ------------      ------------ 
          Net cash provided by (used in) investing activities                     968,408       (10,502,887)       (2,846,356)

Cash flows from financing activities:
   Net increase (decrease) in interest-bearing deposits                        (2,429,143)         (488,016)           98,720
   Cash dividends                                                                 (97,500)          (97,500)          (97,500)
   Increase (decrease) in advance payments by borrowers for
      taxes and insurance                                                         (23,526)           38,849          (134,180)
   Net proceeds from FHLB advances                                                     --         9,200,000                --
   Repayment of ESOP debt                                                         (63,000)               --                --
                                                                             ------------      ------------      ------------   
          Net cash provided by (used in) financing activities                  (2,613,169)        8,653,333          (132,960)
                                                                             ------------      ------------      ------------ 
Net increase (decrease) in cash and cash equivalents                           (1,167,830)       (1,655,977)       (2,636,827)
Cash and cash equivalents at beginning of year                                  6,485,115         8,141,092        10,777,919
                                                                             ------------      ------------      ------------ 
Cash and cash equivalents at end of year                                     $  5,317,285         6,485,115         8,141,092
                                                                             ============      ============      ============
Supplemental information on cash payments:
   Interest paid                                                             $  3,538,547         3,085,728         3,229,074
   Income taxes paid                                                         $    110,000            35,000            96,782
                                                                             
Supplemental information on noncash investing and financing activities:       
   Loans transferred to real estate acquired by foreclosure                  $     88,779            95,541           191,430
   Real estate sold and financed by the Bank                                 $    121,305           108,165                --
   Securities transferred from held to maturity to                           
      available for sale                                                     $         --                --        25,939,464
</TABLE> 

See accompanying notes to consolidated financial statements.

                                       6
<PAGE>
 
                              CFS BANCSHARES, INC.
                                AND SUBSIDIARIES

                  Notes to Consolidated Financial Statements

                          September 30, 1998, 1997 and 1996 


(1)  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

     CFS Bancshares, Inc. is a holding company for Citizens Federal Savings Bank
     (the Bank) and the Bank's wholly-owned subsidiary, Citizens Service
     Corporation - collectively the Company. The holding company was formed June
     30, 1998 and all outstanding shares of the Bank were exchanged for shares
     of the holding company upon formation. The exchange was recorded as a
     pooling of interests whereby the historical basis of the Bank's amounts
     were carried over to the holding company. The Bank is a federally chartered
     stock savings bank regulated by the Office of Thrift Supervision (OTS) and
     certain other federal agencies. The Bank provides a full range of banking
     services to customers through its offices in Birmingham and Eutaw, Alabama.
     The Bank is subject to competition from other financial institutions in the
     market in which it operates. The following is a description of the more
     significant accounting and reporting policies which the Company follows in
     preparing and presenting its financial statements:

     (A)  BASIS OF PRESENTATION

          The consolidated financial statements include the accounts of CFS
          Bancshares, Inc. and its subsidiaries. All intercompany accounts and
          transactions have been eliminated in consolidation.

          The financial statements have been prepared in conformity with
          generally accepted accounting principles. In preparing the financial
          statements, management is required to make estimates and assumptions
          that affect the reported amounts of assets and liabilities and the
          disclosure of contigent assets and liabilities as of the date of the
          balance sheet and revenues and expenses for the period. Actual results
          could differ significantly from those estimates.

          One estimate that is particularly susceptible to a significant change
          in the near term relates to the determination of the allowance for
          loan losses. A significant portion of the Bank's mortgage loans are
          secured by real estate in Alabama, primarily in Jefferson County and
          the surrounding areas. The ultimate collectibility of the loan
          portfolio is susceptible to changes in market conditions in Alabama.

          Management believes that the allowance for loan losses is adequate.
          While management uses available information to recognize losses on
          loans, future additions to the allowance may be necessary based on
          changes in economic conditions. In addition, various regulatory
          agencies, as an internal part of their examination process,
          periodically review the Bank's allowance for loan losses. Such
          agencies may require the Bank to recognize additions to the allowance
          based on their judgments about information available to them at the
          time of their examination.

                                       7
<PAGE>
 
                              CFS BANCSHARES, INC.
                                AND SUBSIDIARIES

                  Notes to Consolidated Financial Statements

                          September 30, 1998, 1997 and 1996


     (B)  CASH AND CASH EQUIVALENTS

          For purposes of reporting cash flows, cash and cash equivalents
          include cash on hand, amounts due from financial institutions and
          federal funds sold. Generally, federal funds are purchased and sold
          for one-day periods.

     (C)  INVESTMENT SECURITIES

          The Bank classifies its investment securities in two categories:
          available for sale or held to maturity. Held to maturity securities
          are those securities for which the Bank has the ability and intent to
          hold the security until maturity. All other securities are classified
          as available for sale.

          Available for sale securities are recorded at fair value. Held to
          maturity securities are recorded at cost adjusted for the amortization
          or accretion of premiums and discounts. Unrealized holding gains and
          losses, net of the related income tax effects, on securities available
          for sale are excluded from earnings and are reported as a separate
          component of stockholders' equity until realized.

          A decline in the market value of any available-for-sale or held-to-
          maturity security below cost that is deemed other than temporary
          results in a charge to earnings and the establishment of a new cost
          basis for the security. At September 30, 1998, the Bank did not have
          any securities with other than temporary declines in value for which a
          new cost basis had not been established.

          Premiums and discounts are amortized or accreted over the life of the
          related investment security as an adjustment to yield using the level-
          yield method and prepayment assumptions. Dividend and interest income
          are recognized when earned. Realized gains and losses for investment
          securities sold are included in earnings and are derived using the
          specific identification method for determining the cost of the
          security sold.

          The investment in the stock of the Federal Home Loan Bank is required
          of insured institutions that utilize the services of the Federal Home
          Loan Bank. The stock has no quoted fair value and no ready market
          exists. However, the Federal Home Loan Bank has historically
          repurchased the stock at cost. Accordingly, the stock is reported in
          the financial statements at cost.

     (D)  LOANS AND INTEREST INCOME
 
          Loans receivable are stated at their unpaid principal balance less the
          undisbursed portion of loans in process, unearned interest income and
          an allowance for loan losses. Interest income on loans is recorded
          using a simple interest method. It is the general policy of the Bank
          to discontinue the accrual of interest when principal or interest
          payments are delinquent 90 days or more or the ultimate collection of
          either is in doubt. Unearned discount on loans purchased is accreted
          to income over the remaining life of the loans purchased using the
          level-yield method.

                                       8
<PAGE>
 
                              CFS BANCSHARES, INC.
                                AND SUBSIDIARIES

                  Notes to Consolidated Financial Statements

                          September 30, 1998, 1997 and 1996


          At September 30, 1998, approximately 18 percent of the Bank's loan
          portfolio consists of mortgage loans to churches. The Bank's exposure
          to credit loss in the event of nonperformance by the parties to
          financial instruments for mortgage loans to churches is represented by
          the contractual amounts of these instruments.

     (E)  ALLOWANCE FOR LOAN LOSSES

          Additions to the allowance for loan losses are based on management's
          evaluation of the loan portfolio under current economic conditions,
          including such factors as the volume and character of loans
          outstanding, past loss experience, and such other factors which, in
          management's judgment, deserve recognition in estimating loan losses.
          Loans are charged to the allowance when, in the opinion of management,
          such loans are deemed to be uncollectible. Provisions for loan losses
          and recoveries of loans previously charged to the allowance are added
          to the allowance.

          One of the procedures used by management in establishing the allowance
          for loan losses is the evaluation of potential impairment on selected
          loans. A loan is considered impaired when, based on current
          information and events, it is probable that the Bank will be unable to
          collect all amounts due according to the contractual terms of the note
          agreement. Impaired loans are measured based on the present value of
          expected future cash flows, discounted at the loan's effective
          interest rate, or at the loan's observable market price, or the fair
          value of the collateral if the loan is collateral dependent. Loans
          that are determined to be impaired require a valuation allowance
          equivalent to the amount of impairment. Impairment losses are included
          in the allowance for loan losses through a charge to the provision for
          loan losses. Cash receipts on impaired loans which are accruing
          interest are applied to principal and interest under the contractual
          terms of the loan agreement. Cash receipts on impaired loans for which
          the accrual of interest has been discontinued are applied to reduce
          the principal amount of such loans until the principal has been
          recovered and are recognized as interest income thereafter.

     (F)  LOAN FEES

          Loan origination fees and certain direct loan origination costs are
          deferred and recognized over the lives of the related loans as a yield
          adjustment using a method which approximates the level-yield method.

     (G)  REAL ESTATE ACQUIRED BY FORECLOSURE

          For real estate acquired through foreclosure, a new cost basis is
          established at the lower of cost or fair value, adjusted for estimated
          costs to sell, at the time of foreclosure. Subsequent to foreclosure,
          foreclosed assets are carried at the lower of fair value less
          estimated costs to sell or cost, with the difference recorded as a
          valuation allowance, on an individual asset basis. Changes in the
          valuation allowance are recognized as charges or credits to earnings.

                                       9
<PAGE>
 
                              CFS BANCSHARES, INC.
                                AND SUBSIDIARIES

                  Notes to Consolidated Financial Statements

                          September 30, 1998, 1997 and 1996


     (H)  INCOME TAXES
 
          The Company provides for income taxes based upon pretax income,
          adjusted for permanent differences between reported and taxable
          earnings. Deferred tax assets and liabilities are recognized for the
          future tax consequences 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 realized 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.


     (I)  PREMISES AND EQUIPMENT

          Land is stated at cost. Premises and equipment are stated at cost less
          accumulated depreciation. Depreciation is provided over the estimated
          useful lives of the respective assets on primarily the straight-line
          method.

     (J)  NET INCOME PER SHARE

          During 1996, the Financial Accounting Standards Board ("FASB") issued
          Financial Accounting Standard No. 128, Earnings per Share, ("FAS128").
          FAS128 specifies the computation, presentation and disclosure
          requirements for earnings per share, replacing the presentation of
          primary earnings per share with the presentation of basic earnings per
          share. For entities with complex capital structures, the presentation
          of fully diluted earnings per share is replaced with diluted earnings
          per share. FAS128 is effective for both interim and annual financial
          statements issued for periods ending after December 15, 1997. The
          Company adopted FAS128 in 1998, and, as required, all periods
          presented in the consolidated financial statements have been restated
          to reflect the adoption of the statement.

          Presented below is a summary of the components used to calculate
          diluted earnings per share for the year ended September 30, 1998,
          1997, and 1996:

<TABLE>
<CAPTION>
                                                                                  YEAR ENDED DECEMBER 31,                        
                                                                              1998         1997       1996  
                                                                             -------------------------------
            <S>                                                              <C>         <C>         <C>    
            DILUTED EARNINGS PER SHARE:                                                                     
             Weighted average common shares                                                                 
               outstanding                                                   127,218     130,000     130,000
             Net effect of the assumed exercise of stock                                                    
               options-based on the treasury stock method                                                   
               using average market price for the year                        12,000          --          --
                                                                             -------     -------     -------
                                                                                                            
             Total weighted average common shares and                                                       
                  potential common stock outstanding                         139,218     130,000     130,000
                                                                             =======     =======     ======= 
</TABLE>

                                      10
<PAGE>
 
                              CFS BANCSHARES, INC.
                                AND SUBSIDIARIES

                  Notes to Consolidated Financial Statements

                          September 30, 1998, 1997 and 1996


     (K)  EMPLOYEE STOCK OWNERSHIP PLAN
 
          The Company sponsors an Employee Stock Ownership Plan which is
          accounted for in accordance with the American Institute of Certified
          Public Accountants' Statement of Position 93-6, Employers' Accounting
          for Employee Stock Ownership Plans.

     (L)  RECENT ACCOUNTING PRONOUNCEMENTS

          In June 1997, the FASB issued Financial Accounting Standard No. 130,
          Reporting Comprehensive Income, ("FAS130"). This standard establishes
          standards for reporting and displaying comprehensive income and its
          components in a full set of general purpose financial statements.
          FAS130 requires all items that are required to be recognized under
          accounting standards as components of comprehensive income be reported
          in a financial statement that is displayed in equal prominence with
          the other financial statements. The term "comprehensive income" refers
          to revenues, expenses, gains, and losses that are included in
          comprehensive income but excluded from earnings under current
          accounting standards. Currently, "other comprehensive income' for the
          Company consists of items recorded in equity under Financial
          Accounting Standard No. 115, Accounting for Certain Investments in
          Debt and Equity Securities. FAS130 is effective for financial
          statements for years beginning after December 15, 1997.

          In June 1997, the FASB issued Financial Accounting Standard No. 131,
          Disclosures about Segments of an Enterprise and Related Information,
          ("FAS131"). FAS131 establishes new standards for the disclosures made
          by public business enterprises to report information about operating
          segments in annual financial statements and requires those enterprises
          to report selected information about operating segments in interim
          financial reports issued to shareholders. It also establishes
          standards for related disclosures about products and services,
          geographic areas, and major customers. FAS131 is effective for
          financial statements for years beginning after December 15, 1997.

          In June 1998, the FASB issued Financial Accounting Standard No. 133,
          Accounting for Derivative Instruments and Hedging Activities,
          ("FAS133"). The standard establishes comprehensive accounting and
          reporting standards for derivative instruments and hedging activities.
          FAS133 requires that all derivative instruments be recorded in the
          statement of financial position at fair value; the accounting for
          gains or losses due to changes in fair value of the derivative
          instruments depends on whether the derivative instruments qualify as
          hedging instruments. If a derivative instrument does not qualify as a
          hedge, the gain or loss is reported in earnings when it occurs.
          However, if the derivative qualifies as a hedging instrument, the
          accounting varies based on the type of risk being hedged, and includes
          either recognizing earnings for changes in fair value each reporting
          period, or accumulating changes in other comprehensive income and
          recognizing earnings during the period that the hedged forecasted item
          impacts earnings. FAS133 is effective for financial statements for the
          first quarter of fiscal years beginning after June 15, 1999. The
          Company has no derivative financial instruments which would be
          accounted for at fair value under FAS133.

                                      11
<PAGE>
 
                              CFS BANCSHARES, INC.
                                AND SUBSIDIARIES

                  Notes to Consolidated Financial Statements

                          September 30, 1998, 1997 and 1996


(2)  CASH AND AMOUNTS DUE FROM DEPOSITORY INSTITUTIONS

     The Bank is required to maintain certain daily reserve balances in
     accordance with the Federal Reserve Board requirements. The Bank exceeded
     the required balances of approximately $25,000 at September 30, 1998 and
     1997.


(3)  INVESTMENT SECURITIES

     The amortized cost and approximate fair value of investment securities held
     to maturity at September 30, 1998 and 1997 were as follows:

<TABLE>
<CAPTION>
                                                                      1998                      1997         
                                                              -------------------   ------------------------ 
                                                              AMORTIZED    FAIR       AMORTIZED       FAIR   
                                                                COST       VALUE        COST          VALUE  
                                                              ---------   -------   -----------     -------- 
              <S>                                           <C>          <C>        <C>             <C>      
              Alabama Minority Enterprise                                                                    
               Small Business Investment                                                                     
               Corporation stock                            $        --         --       25,000        25,000
              Mortgage-backed securities                      4,833,089  4,865,315    6,980,689     7,004,917
              Collateralized mortgage obligations             1,505,041  1,541,124    1,797,704     1,796,581
                                                              ---------  ---------    ---------     ---------
                                                            $ 6,338,130  6,406,439    8,803,393     8,826,498
                                                              =========  =========    =========     ========= 
</TABLE>

     The amortized cost and approximate fair value of investment securities
     available for sale at September 30, 1998 and 1997, were as follows:

<TABLE>
<CAPTION>
                                                                      1998                      1997           
                                                            -------------------------  ------------------------
                                                             AMORTIZED       FAIR       AMORTIZED       FAIR   
                                                                COST         VALUE        COST          VALUE  
                                                            -----------    ----------  ----------    ----------
              <S>                                           <C>            <C>         <C>           <C>       
              U.S. Treasury and U.S.                                                                           
               Government agencies                          $ 2,806,360     2,811,127  11,468,592    11,523,106 
              Equity securities                               2,583,543     2,576,921   2,439,885     2,445,671 
              Mortgage-backed securities                     15,843,419    15,859,592   9,692,496     9,716,660 
              Collateralized mortgage obligations             7,877,536     7,875,097  12,271,969    12,229,755 
                                                             ----------    ----------  ----------    ---------- 
                                                            $29,110,859    29,122,737  35,872,942    35,915,192 
                                                             ==========    ==========  ==========    ========== 
</TABLE>

     The gross unrealized gains and losses of investment securities held to
     maturity at September 30, 1998 and 1997, are as follows:

<TABLE>
<CAPTION> 
                                                                      1998                      1997             
                                                            ---------------------   -------------------------  
                                                               GROSS      GROSS        GROSS         GROSS   
                                                            UNREALIZED UNREALIZED    UNREALIZED    UNREALIZED
                                                               GAINS     LOSSES        GAINS         LOSSES  
                                                            ----------  ---------   -----------    ----------  
              <S>                                           <C>         <C>         <C>             <C>       
              Mortgage-backed securities                    $  32,514        288       52,530         28,302 
              Collateralized mortgage obligations              36,083         --           --          1,123 
                                                              -------     ------       ------         ------ 
                                                            $  68,597        288       52,530         29,425 
                                                              =======     ======       ======         ======  
</TABLE>

                                      12
<PAGE>
 
                              CFS BANCSHARS, INC.
                               AND SUBSIDIARIES

                  Notes to Consolidated Financial Statements

                       September 30, 1998, 1997 and 1996                       

The gross unrealized gains and losses of investment securities available for
sale at September 30, 1998 and 1997 are as follows:

<TABLE>
<CAPTION>
                                                  1998                    1997
                                         ----------------------  ----------------------
                                             GROSS     GROSS       GROSS       GROSS
                                         UNREALIZED  UNREALIZED  UNREALIZED  UNREALIZED
                                             GAINS     LOSSES      GAINS       LOSSES
                                         ----------  ----------  ----------  ----------
  <S>                                    <C>         <C>         <C>         <C>    
  U.S. Treasury and U.S.
   Government agencies                   $    4,767          --      70,118      15,604
  Equity securities                              --       6,622       5,786          --
  Mortgage-backed securities                 62,237      46,064      42,184      18,020
  Collateralized mortgage obligations         5,251       7,690      22,786      65,000
                                             ------      ------     -------  ----------
                                         $   72,255      60,376     140,874      98,624
                                             ======      ======     =======  ==========
</TABLE>

The amortized cost and approximate fair value of debt investment securities
available for sale at September 30, 1998, by contractual maturities are shown
below. Actual maturities could differ from contractual maturities due to call or
prepayment provisions.

<TABLE>
<CAPTION>      
                                                       AMORTIZED     FAIR
                                                          COST       VALUE
                                                      ----------   ---------
     <S>                                              <C>          <C>       
     Due from one to five years                       $ 1,806,151   1,808,626
     Due from five to ten years                         1,000,209   1,002,500
     Mortgage-backed securities and collateralized
      mortgage obligations                             23,720,956  23,734,690
                                                      -----------  ----------
                                                      $26,527,316  26,545,816
                                                      ===========  ==========
</TABLE>

There were no sales of investment securities available for sale in 1996.
Proceeds from sales of investment securities available for sale were $5,890,772
and $7,119,866 for the years ended September 30, 1998 and 1997, respectively.
Gross gains of $43,717 and $140,829 were realized on those sales for the years
ended September 30, 1998 and 1997, respectively.

In 1998, an investment of $25,000 in a community small business incubator was
written off when the incubator filed for bankruptcy.

Investment securities with amortized cost of $24,590,595 and $29,558,918 at
September 30, 1998 and 1997, respectively, were pledged to secure public
deposits as required by law and for other purposes. Additionally, in accordance
with Office of Thrift Supervision regulations, the Bank is required to maintain
a certain percentage (4 percent at September 30, 1998), of its withdrawable
deposits and current borrowings in cash, U.S. Treasury obligations, or other
approved investments which are readily convertible into cash. The Bank met this
liquidity requirement at September 30, 1998.

                                      13
<PAGE>
 
                             CFS BANCSHARES, INC.
                               AND SUBSIDIARIES

                  Notes to Consolidated Financial Statements
                       September 30, 1998, 1997 and 1996

     During 1996, the Bank transferred investment securities with an amortized
     cost of $25,939,464 from held to maturity to available for sale. The fair
     market value of the investment securities on the date of transfer was
     $25,924,334 resulting in a decrease in the unrealized gain on investment
     securities available for sale of $15,130. The investment securities were
     transferred as a result of the reassessment of the appropriateness of the
     classification of all securities following the issuance of the FASB Special
     Report, A Guide to Implementation of Statement 115 on Accounting for
     Certain Investments in Debt and Equity Securities.

(4)  LOANS

     At September 30, 1998 and 1997, the Bank had the following net loans:

<TABLE>
<CAPTION>
                                                                                                               1998        1997
                                                                                                            ----------  ----------
             <S>                                                                                           <C>          <C>
             Total loans                                                                                   $47,047,687  44,134,410
             Less:    Unearned discount on loans purchased                                                       2,296       5,750
                      Unamortized loan origination fees                                                        577,277     564,077
                      Undisbursed portion of loans in process                                                  500,833     361,283
                      Allowance for loan losses                                                                553,797     630,423
                                                                                                            ----------  ----------
                                                                                                             1,634,203   1,561,533
                                                                                                            ----------  ----------
             Net loans                                                                                     $45,413,484  42,572,877
                                                                                                            ==========  ==========
</TABLE> 

       The composition of the total loan portfolio was as follows:

<TABLE>
<CAPTION> 
                                                                                                               1998        1997
                                                                                                            ----------  ----------
             <S>                                                                                           <C>          <C>  
             Residential real estate mortgage                                                             $ 32,775,332  30,542,426
             Consumer installment                                                                            2,023,944   2,204,929
             Nonresidential mortgage                                                                        11,558,710  11,066,054
             Commercial                                                                                        689,701     321,001
                                                                                                            ----------  ----------
                      Total loans                                                                         $ 47,047,687  44,134,410
                                                                                                            ==========  ==========
</TABLE>

   A summary of the transactions in the allowance for loan losses for the years
   ended September 30, 1998, 1997, and 1996 follows:

<TABLE>
<CAPTION>
                                             1998       1997      1996
                                          ---------  --------  --------
      <S>                              <C>           <C>       <C>
      Balance at beginning of year     $   630,423   638,770   659,734
      Net charge-offs:
      Gross charge-offs                   (314,990)  (25,056)  (59,566)
      Gross recoveries                      62,364    16,709    38,602
      Provision charged to earnings        176,000        --        --
                                          --------   -------   -------
      Balance at end of year           $   553,797   630,423   638,770
                                          ========   =======   =======
</TABLE>

                                      14
<PAGE>
 
                              CFS BANCSHARS, INC.
                               AND SUBSIDIARIES

                  Notes to Consolidated Financial Statements

                       September 30, 1998, 1997 and 1996                       

     Impaired loans at September 30, 1998 and 1997 totaled $225,435 and
     $427,992, respectively. The allowance amounts, which were $225,435 and
     $287,792 in 1998 and 1997, respectively, were primarily determined using
     the fair value of the related collateral. The average recorded investment
     in impaired loans for the years ended September 30, 1998 and 1997, was
     $300,639 and $365,000, respectively. The interest income recognized on
     impaired loans for the years ended September 30, 1998, 1997, and 1996 was
     approximately $410, $6,041, and $2,445, respectively.

(5)  PREMISES AND EQUIPMENT

Premises and equipment are summarized as follows:

<TABLE>
<CAPTION>
                                                        1998       1997
                                                     ---------   ---------
             <S>                                     <C>         <C> 
             Land                                    $  733,242    733,242
             Buildings and leasehold improvements     3,026,861  3,018,361
             Furniture, fixtures and equipment        2,029,126  1,938,336
                                                      ---------  ---------
                                                      5,789,229  5,689,939
             Less:  accumulated depreciation          1,758,233  1,486,995
                                                      ---------  ---------
                                                     $4,030,996  4,202,944
                                                      =========  =========
</TABLE>

(6)  REAL ESTATE ACQUIRED BY FORECLOSURE

     Real estate acquired by foreclosure, net, as of September 30, 1998 and 1997
     totaled $59,634 and $99,494, respectively. There were no transactions in
     the allowance for losses on the real estate acquired by foreclosure in 1998
     or 1997. 

                                      15
<PAGE>
 
                              CFS BANCSHARS, INC.
                               AND SUBSIDIARIES

                  Notes to Consolidated Financial Statements

                       September 30, 1998, 1997 and 1996                       

(7)  INTEREST-BEARING DEPOSITS

     At September 30, 1998 and 1997, the composition of interest-bearing
     deposits an applicable interest rates was as follows:

<TABLE>
<CAPTION>
                                                                                                                1998         1997
                                                                                                             -----------  ----------
          <S>                                                                                              <C>            <C>
          NOW accounts (1998 - .50%, 1997 - 1.00%)                                                         $   8,000,629   9,435,520
          Super NOW accounts (1998 - 2.75%, 1997 - 2.75%)                                                      4,366,743   3,566,811
          Passbook savings (1998 - 2.75%, 1997 - 2.75%)                                                       17,539,298  18,615,013
          Time deposits:                                                             
            Certificates of deposit (1998 - 4.63% to 8.50%, 1997 - 4.75% to 8.50%)                            
            Jumbo accounts (1998 - 4.87% to 5.75%, 1997 - 4.65% to                                           20,321,138   24,160,256
              6.00%)                                                                                         23,534,054   20,413,405
                                                                                                             ----------   ----------
                 Total time deposits                                                                         43,855,192   44,573,661

          Accrued interest on deposits                                                                          130,327      154,721
                                                                                                             ----------   ----------
                 Total deposits                                                                            $ 73,892,189   76,345,726
                                                                                                             ==========   ==========
</TABLE> 
 
     Weighted average interest rates on deposit accounts were as follows at
     September 30, 1998 and 1997:

<TABLE> 
<CAPTION>  
                                                                                                                1998         1997
                                                                                                             ----------   ----------
          <S>                                                                                                <C>          <C>       
          NOW and demand deposit accounts                                                                        .50%        .88% 
          Super NOW accounts                                                                                    2.75%       2.75% 
          Passbook savings accounts                                                                             2.74%       2.75% 
          Certificates of deposit                                                                               5.22%       5.27% 
          Jumbo accounts                                                                                        5.15%       5.28% 
            Total                                                                                               3.74%       4.01% 
</TABLE> 

     Interest on deposits is summarized as follows: 
 
<TABLE> 
<CAPTION> 
                                                                                                    1998        1997         1996
                                                                                                 ----------  ----------   ----------
          <S>                                                                                   <C>          <C>          <C>     
          NOW accounts                                                                          $    86,957      94,328       92,221
          Super NOW accounts                                                                         96,667     118,974      135,595
          Passbook savings                                                                          478,354     486,639      507,602
          Time deposits                                                                           2,275,177   2,362,246    2,433,501
                                                                                                 ----------  ----------   ----------
                                                                                                $ 2,937,155   3,062,187    3,168,919
                                                                                                 ==========  ==========   ==========
</TABLE>

                                      16
<PAGE>
 
                             CFS BANCSHARES, INC.
                               AND SUBSIDIARIES

                  Notes to Consolidated Financial Statements

                       September 30, 1998, 1997 and 1996

     The amounts and maturities of time deposits at September 30, 1998 and 1997
     are as follows:

<TABLE>
<CAPTION>
                                           1998        1997
                                        ----------  ----------
          <S>                        <C>            <C>
          Within one year            $  35,839,486  37,156,692
          Within two years               4,858,752   2,898,609
          Within three years               966,475   2,844,905
          Within four years              1,059,345     237,967
          Within five years                861,070   1,173,004
          Greater than five years          270,064     262,484
                                        ----------  ----------
                                     $  43,855,192  44,573,661
                                        ==========  ========== 
</TABLE>

(8)  BORROWED FUNDS

     The Company was liable to the Federal Home Loan Bank of Atlanta on the
     following advances at September 30, 1998:

<TABLE>
<CAPTION>
                                                    FIXED
         MATURITY DATE                          INTEREST RATE     1998
         --------------                         -------------  -----------
         <S>                                    <C>            <C>  
         September 2002                             5.66%      $ 5,000,000
         June 2008                                  5.51%        4,200,000
                                                               -----------
            Total (weighted average rate of 5.60%)             $ 9,200,000
                                                               ===========
</TABLE>

     At September 30, 1998, the advances were collateralized by a blanket pledge
     of first-mortgage residential loans. The September 2002 advance and the
     June 2008 advance are callable in September 1999 and June 2003,
     respectively.

 (9) INCOME TAXES

     For the years ended September 30, 1998, 1997, and 1996, income tax expense
     (benefit) consists of the following:

<TABLE>
<CAPTION>
                                               1998      1997      1996
                                             --------  --------  ---------
        <S>                                  <C>       <C>       <C>
        Current:                      
          Federal                            $ 88,604  (43,520)   161,495
          State                                    --   (8,862)    18,063
                                             --------  -------   --------
                                               88,604  (52,382)   179,558
                                             --------  -------   --------
        Deferred:                     
          Federal                              37,606  220,908   (250,985)
          State                                 5,525   31,666    (30,108)
                                             --------  -------   --------
                                               43,131  252,574   (281,093)
                                             --------  -------   --------
                                             $131,735  200,192   (101,535)
                                             ========  =======   ========
</TABLE>

                                      17
<PAGE>
 
                             CFS BANCSHARES, INC.
                               AND SUBSIDIARIES

                  Notes to Consolidated Financial Statements

                       September 30, 1998, 1997 and 1996

     The income tax expense above represents an effective tax rate of 37.6
     percent, 35.9 percent, and 34.4 percent, for 1998, 1997 and 1996,
     respectively. The actual income tax expense (benefit) for 1998, 1997 and
     1996 differs from the "expected" income tax expense (benefit) for those
     years which is computed by applying the U.S. Federal corporate income tax
     rate of 34.0 percent for 1998, 1997 and 1996 to income before income taxes
     as follows:
   
<TABLE>
<CAPTION>
                                                                 1998      1997      1996   
                                                               --------  --------  --------
       <S>                                                  <C>          <C>       <C>       
        Computed "expected" income tax (expense) benefit    $  119,233   189,831   (100,272) 
        State tax, net of federal effect                         4,208    15,051     (8,354) 
        Dividends paid to ESOP                                  (6,824)   (7,205)    (7,326) 
        Other, net                                              15,118     2,515     14,417  
                                                               -------   -------   --------
                                                            $  131,735   200,192   (101,535) 
                                                               =======   =======   ========
</TABLE>

     The tax effects of temporary differences that give rise to significant
     portions of the deferred tax assets and deferred tax liabilities at
     September 30, 1998 and 1997 are presented below:

<TABLE>
<CAPTION>
                                                                           1998        1997
                                                                         --------    --------
        <S>                                                             <C>          <C>
        Deferred tax assets:
         Loans - allowance for loan losses                              $103,645       84,338
         Loans - unearned loan fee income                                 20,099       31,755   
                                                                                              
         Capital loss carryforward                                         8,500           --  
         Nonaccrual interest                                              46,320           --  
         Foreclosed property                                              23,521           --  
         Accrued legal fees                                               20,718           --  
         Prepaid expenses and accruals                                     7,229       34,312 
         Other                                                            29,240       31,981  
                                                                        --------      ------- 
                                                                         259,272      182,386
                                                                        --------      -------
    
        Deferred tax liabilities:
         FHLB stock                                                       52,128       52,128  
         Unrealized gain on investment securities available for sale       4,279       15,212  
         Premises and equipment - differences in depreciation expense     49,231       23,005  
         Loan basis - book to tax difference                              93,704           --  
         Other                                                             2,741        2,656  
                                                                        --------      -------  
                                                                         202,083       93,001  
                                                                        --------      -------   
        Net deferred tax asset                                          $ 57,189       89,385
                                                                        ========      =======
</TABLE>

     Management believes results of future operations will generate sufficient
     taxable income and resulting tax liabilities to realize the deferred tax
     asset. There was no valuation allowance at September 30, 1998 or 1997, or
     any change in the valuation allowance during the years ended September 30,
     1998, 1997 or 1996.

                                      18
<PAGE>
 
                             CFS BANCSHARES, INC.
                               AND SUBSIDIARIES

                  Notes to Consolidated Financial Statements

                       September 30, 1998, 1997 and 1996


(10) EMPLOYEE BENEFITS PLANS

     The Company sponsors an Employee Stock Ownership Plan (ESOP). The ESOP is
     available to all employees who have met certain age and service
     requirements. Contributions to the plan are determined by the board of
     directors, based on a percentage of the total payroll and certain
     limitations as to the deductibility for tax purposes. The Company intends
     to make contributions to the Plan that, when combined with dividends on
     unallocated shares, are sufficient to fund interest and principal payments
     on the ESOP debt. The ESOP has borrowed funds on three occasions to
     purchase shares of common stock of the Bank for the benefit of the ESOP
     participants.

     The common stock of the Company acquired by the ESOP is held as collateral
     for the loans. As of September 30, 1998, the ESOP holds 30,765 (24 percent)
     shares of the Company's outstanding stock, of which 20,440 shares have been
     allocated to the participants. The Company makes contributions to the ESOP
     which are used to make loan interest and principal payments. Shares are
     released and allocated to the participants prorata with the paydowns on the
     ESOP debt. All dividends paid on allocated and unallocated shares are used
     to reduce interest expense related to the ESOP debt.

     The first ESOP loan (1989 loan) is due on demand and is repayable in
     monthly installments of interest at 80 percent of the prime rate or $4,912,
     $7,307, and $9,632 for the years ended September 30, 1998, 1997, and
     1996, respectively, and annual installments of principal in the amount of
     $41,275. The interest rate is 6.8 percent at September 30, 1998 and 1997.
     The principal outstanding is $41,275 and $82,550 at September 30, 1998 and
     1997, respectively.

     The second ESOP loan (1995 loan) is repayable in annual installments of
     interest at 6.75 percent and annual installments of principal in the amount
     of $24,195. The principal outstanding at September 30, 1998 and 1997 is
     $24,196 and $48,391, respectively. The principal balance approximates the
     fair value of the unearned shares securing the loan (1995 shares) of 559
     and 1,119 at September 30, 1998 and 1997, respectively.

     The third ESOP loan (1998 loan) is repayable in monthly installments of
     interest at the prime rate and annual installments of principal in the
     amount of $8,000. The loan originated on March 9, 1998 to purchase 4,005
     shares (1998 shares). The principal oustanding at September 30, 1998 was
     $80,000 and the fair value of the 4,005 unearned shares was $210,263.

     Contributions to fund the installments on the 1989 loan are recorded as
     compensation expense. Such contributions approximated $46,000, $49,000 and
     $52,000 in 1998, 1997, and 1996, respectively. The fair value of the
     committed-to-be-released 1995 and 1998 shares are also reported as
     compensation expense. Such shares totaled 760, 560, and 560 for 1998, 1997,
     and 1996 respectively. The related compensation expense approximated
     $39,000, $22,400, and $23,520 for 1998, 1997, and 1996, respectively.

                                      19
<PAGE>
 
                             CFS BANCSHARES, INC.
                               AND SUBSIDIARIES

                  Notes to Consolidated Financial Statements

                       September 30, 1998, 1997 and 1996

     The Bank also sponsors a 401(k) retirement plan (401(k)). The 401(k) is a
     trusteed, salary reduction plan which is available to all employees who
     have completed one year of service and have attained the age of 21. 401(k)
     participants may elect to defer a percentage of their compensation each
     year up to a certain dollar limit established by law. The Bank's management
     may make a discretionary matching contribution equal to a percentage of the
     amount of salary reduction 401(k) participants elected to defer. Such
     discretionary contributions for the years ended September 30, 1998, 1997,
     and 1996 were $24,994, $21,800, and $25,952, respectively. The Bank also
     provides major medical and dental coverage funded through pre-tax
     withholdings from the participants.

(11) STOCKHOLDERS' EQUITY

     The Bank is 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 financial statements. Under capital
     adequacy guidelines and the regulatory framework for prompt corrective
     action, the Company must meet specific capital guidelines that involve
     quantitative measures of the Company's assets, liabilities, and certain 
     off-balance-sheet items as calculated under regulatory accounting
     practices. The Company'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 regulations to ensure capital adequacy
     require the Company to maintain minimum amounts and ratios (set forth in
     the table below) of total and Tier I capital to risk-weighted assets, and
     of Tier I capital to average assets as set forth in the table below.

<TABLE>
<CAPTION>
                                                                                 FOR CAPITAL                    WELL                
                                                     ACTUAL                  ADEQUACY PURPOSES              CAPITALIZED            
                                        --------------------------       ------------------------     -----------------------    
                                         AMOUNT          RATIO            AMOUNT         RATIO          AMOUNT      RATIO         
                                        -----------    -----------       -----------   ----------     -----------  ----------    
         <S>                            <C>            <C>               <C>           <C>            <C>          <C>
         As of September 30, 1998:
          Total capital
           (to risk weighted assets)    $8,272,808       18.2%           $3,626,080      8.0%        $4,532,600        10.0%        
          Tier I capital                                                                                               
           (to risk weighted assets)    $7,900,450       17.4%            1,813,040      4.0%         2,719,560         6.0%
          Tier I capital                                                                                              
           (to average assets)          $7,900,450        8.3%            3,798,286      4.0%         4,747,857         5.0%
</TABLE>                     

                                      20
<PAGE>
 
                             CFS BANCSHARES, INC.
                               AND SUBSIDIARIES

                  Notes to Consolidated Financial Statements

                       September 30, 1998, 1997 and 1996
     
<TABLE> 
<CAPTION>
                                                                                     TO BE WELL
                                                                                  CAPITALIZED UNDER
                                                              FOR CAPITAL         PROMPT CORRECTIVE
                                           ACTUAL          ADEQUACY PURPOSES      ACTION PROVISIONS
                                   --------------------  --------------------  ----------------------
                                      AMOUNT      RATIO     AMOUNT     RATIO     AMOUNT      RATIO
                                   -----------  -------  -----------  -------  -----------  ---------
     <S>                           <C>          <C>      <C>          <C>      <C>          <C>
     As of September 30, 1997:
      Total capital
       (to risk weighted assets)    $8,007,691   17.5%   $3,655,338    8.0%    $4,581,667     10.0%
      Tier I capital                                                                              
       (to risk weighted assets)    $7,770,829   17.0%    1,832,667    4.0%     2,749,000      6.0%
      Tier I capital                                                                              
       (to average assets)          $7,770,829    9.0%    3,459,160    4.0%     4,323,950      5.0% 
</TABLE>

     Savings institutions with more than a "normal" level of interest rate risk
     are required to maintain additional total capital. A savings institution
     with a greater than normal interest rate risk is required to deduct
     specified amounts from total capital, for purposes of determining its
     compliance with risk-based capital requirements. The Bank was in compliance
     with capital standards at September 30, 1998 and 1997.

     Retained earnings at September 30, 1998 and 1997, include approximately
     $2,200,000 for which no provision for income tax has been made. This amount
     represents allocations of income to bad debt deductions for tax computation
     purposes. If, in the future, this portion of retained earnings is used for
     any purpose other than to absorb tax bad debt losses, income taxes may be
     imposed at the then applicable rates. An additional $1,400,000 of retained
     earnings is also restricted at September 30, 1998 and 1997, as a result of
     the liquidation account established upon conversion to a stock company. No
     dividends may be paid to stockholders if such dividends would reduce the
     net worth of the Bank below the amount required by the liquidation account.

(12) CONTINGENT LIABILITIES AND COMMITMENTS

     The Company is defending various lawsuits and claims arising out of the
     conduct of its business. While the ultimate results of these lawsuits and
     claims cannot be predicted with certainty, in the opinion of management,
     the ultimate disposition of these matters will not have a significant
     effect on the consolidated financial position or results of operations of
     the Company.

     Effective October 18, 1996 and July 23, 1998, the Bank entered into
     Agreements with the Office of Thrift Supervision (OTS) intended to correct
     certain deficiencies, about which the OTS expressed supervisory concern.
     Pursuant to the Agreements, the Bank agreed to adopt certain guidelines,
     procedures and policies. The Bank also agreed to adopt a business plan
     covering such matters as lending activities, operating expenses, operating
     results and other matters. 

                                      21
<PAGE>
 
                             CFS BANCSHARES, INC.
                               AND SUBSIDIARIES

                  Notes to Consolidated Financial Statements

                       September 30, 1998, 1997 and 1996

     The Company believes it is in substantial compliance with or will be in
     compliance with the terms of the Agreements within the time periods stated
     within the agreements. If the Bank were not to comply with the Agreements,
     the OTS would have certain enforcement rights, possibly including the right
     to commence an action to remove directors and/or officers or to appoint a
     conservator or a receiver for the Bank. Although compliance with the
     agreements has not had and is not expected to have a material impact on the
     operations of the Bank, there can be no assurance that the Agreements will
     not have an adverse impact on the Bank's future operations.

(13) OFF-BALANCE-SHEET FINANCIAL INSTRUMENTS

     The Bank 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.
     These financial instruments include commitments to extend credit. Such
     instruments involve elements of credit risk in excess of the amounts
     recognized in the financial statements.

     The Bank's exposure to credit loss in the event of nonperformance by the
     other party to the financial instrument for commitments to extend credit is
     represented by the contractual amount of these instruments. The Bank uses
     the same credit policies in making commitments and conditional obligations
     as it does for on-balance-sheet instruments.

     The off-balance sheet financial instruments whose contract amounts
     represent credit risk as of September 30, 1998, are as follows:

<TABLE>
            <S>                                    <C> 
            Commitments to extend credit           $ 1,785,200
            Commitments to fund lines of credit        298,449
                                                     ---------
                                                   $ 2,083,649
                                                     =========
</TABLE>

     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 some of the commitments are
     expected to expire without being drawn upon, the total commitment amounts
     do not necessarily represent future cash requirements.

(14) OTHER EXPENSE

     Components of other expense exceeding 1 percent of total interest and other
     income included miscellaneous losses of $116,708 in 1996, consisting
     primarily of costs related to bank robberies and settlements of and
     provisions for various legal issues. There were no such components
     exceeding the 1 percent criteria as stated which are not presented
     separately in the 1998 and 1997 consolidated statements of operations. 

                                      22
<PAGE>
 
                             CFS BANCSHARES, INC.
                               AND SUBSIDIARIES

                  Notes to Consolidated Financial Statements

                       September 30, 1998, 1997 and 1996


(15) STOCK OPTION PLAN

     In 1991, under the terms of the Bank's incentive stock option plan, the
     Bank granted 12,000 common stock options to officers and key employees.
     The exercise price for the options is equal to $14 per share.  All options
     are exercisable through 2001.  As of September 30, 1998, no options had
     been exercised.


(16) SAVINGS ASSOCIATION INSURANCE FUND SPECIAL ASSESSMENT

     On September 30, 1996, the Federal Deposit Insurance Corporation imposed a
     special assessment on Savings Association Insurance Fund (SAIF) assessable
     deposits of depository institutions to recapitalize the SAIF. The Bank's
     assessment of $493,687 was reflected in the statement of operations for the
     year ended September 30, 1996.


(17) FAIR VALUE OF FINANCIAL INSTRUMENTS

     The following table provides fair values of the Bank's financial
     instruments at September 30, 1998 and 1997. Fair value estimates are made
     at a specific point in time, based on relevant market information and
     information about the financial instrument. These estimates do not reflect
     any premium or discount that could result from offering for sale at one
     time the Bank's entire holdings of a particular financial instrument.
     Because no market exists for a portion of the Bank's financial instruments,
     fair value estimates are based on judgments regarding future expected loss
     experience, current economic conditions, risk characteristics of various
     financial instruments, and other factors. These estimates are subjective in
     nature and involve uncertainties and matters of significant judgment and,
     therefore, cannot be determined with precision. Changes in assumptions
     could significantly affect the estimates. Fair value estimates are based on
     existing on and off-balance sheet financial instruments without attempting
     to estimate the value of anticipated future business and the value of
     assets and liabilities that are not considered financial instruments. In
     addition, the tax ramifications related to the realization of the
     unrealized gains and losses can have a significant effect on fair value
     estimates and have not been considered in any of the estimates. The
     assumptions used in the estimation of the fair value of the Bank's
     financial instruments are explained below. Where quoted market prices are
     not available, fair values are based on estimates using discounted cash
     flow and other valuation techniques. Discounted cash flows can be
     significantly affected by the assumptions used, including the discount rate
     and estimates of future cash flows. The following fair value estimates
     cannot be substantiated by comparison to independent markets and should not
     be considered representative of the liquidation value of the Bank's
     financial instruments, but rather a good-faith estimate of the fair value
     of financial instruments held by the Bank.

     The following methods and assumptions were used by the Bank in estimating
     the fair value of its financial instruments:

     Cash and Cash Equivalents and Interest-earning Deposits in Other Banks --
     Fair value equals the carrying value of such assets due to their nature.

                                      23
<PAGE>
 
                             CFS BANCSHARES, INC.
                               AND SUBSIDIARIES

                  Notes to Consolidated Financial Statements

                       September 30, 1998, 1997 and 1996


   Investment Securities and Accrued Interest Receivable -- The fair value of
   investments is based on quoted market prices.  The carrying amount of related
   accrued interest receivable approximates its fair value.

   Federal Home Loan Bank Stock -- The Federal Home Loan Bank has historically
   repurchased its stock at cost.  Therefore, the carrying amount is considered
   a reasonable estimate of its fair value.

   Loans Receivable -- The fair value of loans is calculated using discounted
   cash flows by loan type.  The discount rate used to determine the present
   value of the loan portfolio is an estimated market discount rate that
   reflects the credit and interest rate risk inherent in the loan portfolio.
   The estimated maturity is based on the Bank's historical experience with
   repayments adjusted to estimate the effect of current market conditions.  The
   carrying amount of related accrued interest receivable approximates its fair
   value.

   Deposits -- Fair values for certificates of deposit have been determined
   using discounted cash flows.  The discount rate used is based on estimated
   market rates for deposits of similar remaining maturities.  The carrying
   amount of all other deposits, due to their short-term nature, approximate
   their fair values.  The carrying amount of related accrued interest payable
   approximates its fair value.

   FHLB Advances -- Fair value has been determined using discounted cash flows.
   The discount rate used is based on estimated current rates for advances with
   similar maturities.

<TABLE>
<CAPTION>
                                                              1998                    1997
                                                     ----------------------  ----------------------
                                                                 ESTIMATED               ESTIMATED
                                                      CARRYING      FAIR      CARRYING      FAIR
                                                       AMOUNT      VALUE       AMOUNT      VALUE
                                                     ----------  ----------  ----------  ----------
     <S>                                          <C>            <C>         <C>         <C>
     Financial assets:
      Cash and cash equivalents                   $   5,317,285   5,317,285   6,485,115   6,485,115
      Interest-earning deposits in other banks          159,515     159,515     157,574     157,574
      Investment securities                          35,460,867  35,529,176  44,718,585  44,741,690
      Federal Home Loan Bank stock                      670,000     670,000     460,000     460,000
      Loans receivable, net                          45,413,484  46,655,779  42,572,877  43,737,467
      Accrued interest receivable                       641,313     641,313     639,800     639,800
 
     Financial liabilities:
      Deposits, including accrued
          interest payable                           73,892,189  74,083,190  76,345,726  76,197,065
      FHLB advances                                   9,200,000   9,546,000   9,200,000   9,202,000
</TABLE>

                                      24
<PAGE>
 
                             CFS BANCSHARES, INC.
                               AND SUBSIDIARIES

                  Notes to Consolidated Financial Statements

                       September 30, 1998, 1997 and 1996


(18) DIVIDENDS FROM SUBSIDIARY

     Dividends paid by the subsidiary bank are the primary source of funds
     available to the Company for payment of dividends to its stockholders and
     for other needs.  Applicable federal and state statutes and regulations
     impose restrictions on the amounts of dividends that may be declared by the
     subsidiary bank.  In addition, the subsidiary bank is also required to
     maintain minimum amounts of capital to total "risk-weighted" assets, as
     defined by banking regulators.  Capital adequacy considerations could
     further limit the availability of dividends from the subsidiary bank.  At
     September 30, 1998, the Bank could have declared dividends of approximately
     $3,188,000 without prior approval of regulatory authorities.  Accordingly,
     at September 30, 1998, approximately $4,750,000 of the parents investment
     in its subsidiary was restricted from transfer in the form of dividends.


(19) PARENT COMPANY FINANCIAL INFORMATION

     The condensed financial information for CFS Bancshares, Inc. (Parent
     Company Only) is presented as follows:


                             (PARENT COMPANY ONLY)
                            CONDENSED BALANCE SHEET
                              SEPTEMBER 30, 1998

<TABLE>
<CAPTION>
<S>                                                       <C> 
          ASSETS
 Cash                                                     $    100,000
 Investment in subsidiary Bank                               7,938,297
                                                          ------------
     Total assets                                         $  8,038,297
                                                          ============
 
          LIABILITIES

 Note payable (ESOP debt)                                 $    145,471
 Other liabilities                                              30,939
                                                          ------------
     Total liabilities                                         176,410
                                                          ------------
 
     STOCKHOLDERS' EQUITY

Serial preferred stock                                              --
Common stock                                                   130,000
Additional paid-in capital                                   1,160,760
Retained earnings                                            6,708,996
Unrealized gain on investment securities of subsidiary           7,602
Employee Stock Ownership Plan debt                            (145,471)
                                                          ------------
     Total stockholders' equity                              7,861,887
                                                          ------------
     Total liabilities and stockholders' equity           $  8,038,297
                                                          ============
</TABLE>

                                      25
<PAGE>
 
                             CFS BANCSHARES, INC.
                               AND SUBSIDIARIES

                  Notes to Consolidated Financial Statements

                       September 30, 1998, 1997 and 1996



                             (PARENT COMPANY ONLY)
                       CONDENSED STATEMENT OF OPERATIONS
          PERIOD FROM JUNE 30, 1998 (INCEPTION) TO SEPTEMBER 30, 1998

<TABLE>
<CAPTION>
Income:
   <S>                                          <C>
     Cash dividends from Bank                   $  100,000
 
   Expense                                          30,939
                                                ----------
     Earnings before equity in undistributed
      earnings of subsidiary                        69,061
     Equity in undistributed earnings
      of subsidiary                                 76,675
                                                ----------
      Net earnings                              $  145,736
                                                ==========
</TABLE>

                                      26
<PAGE>
 
                             CFS BANCSHARES, INC.
                               AND SUBSIDIARIES

                  Notes to Consolidated Financial Statements

                       September 30, 1998, 1997 and 1996




                             (PARENT COMPANY ONLY)
                       CONDENSED STATEMENT OF CASH FLOWS
          PERIOD FROM JUNE 30, 1998 (INCEPTION) TO SEPTEMBER 30, 1998

<TABLE>
<S>                                          <C>
Cash flows from operating activities:
 Net earnings                                $145,736
 Adjustments to reconcile net earnings
   to net cash provided by
   operating activities:
     Equity in undistributed
      earnings of subsidiary                  (76,675)
     Increase  in other liabilities            30,939
                                             --------
         Net cash provided by
          operating activities                100,000
                                             --------
 
Net increase in cash                          100,000
 
Cash at beginning of year                          --
                                             --------
 
Cash at end of year                          $100,000
                                             ========
</TABLE> 
 
                                      27
<PAGE>
 
                             CORPORATE INFORMATION
                                        


                            CORPORATE HEADQUARTERS

                            1700 3/rd/ Avenue North
                           Birmingham, Alabama 35203
                                (205) 328-2041


        BESSEMER OFFICE                                  EUTAW OFFICE    
                                                                         
        2100 Bessemer Road                              213 Main Street  
   Birmingham, Alabama 35208                          Eutaw, Alabama 35462
         (205) 214-3000                                 (205) 372-9307    



    STOCK TRANSFER AGENT                             INDEPENDENT AUDITORS
                                       
   Registrar and Transfer Company                    KPMG Peat Marwick LLP
  10 Commerce Drive                                 Certified Public Accountants
  Cranford, New Jersey 07016                        Financial Center, Suite 1200
                                                    Birmingham, Alabama 35203



                                ANNUAL MEETING

                             The Annual Meeting of
                       CFS Bancshares, Inc. will be held
                          January 27, 1999 at 2:00 PM
                          Second Floor Auditorium at
                              300 North 18 Street
                              Birmingham, Alabama


                             SPECIAL LEGAL COUNSEL

                     Housley, Kantarian & Bronstein, P.C.
                        1220 19th Street NW, Suite 700
                             Washington, DC 20036


                                  FORM 10-KSB

A copy of Form 10-KSB, including financial statement schedules as filed with the
Securities and Exchange Commission will be furnished without charge to
stockholders of the record date upon written request to the secretary, CFS
Bancshares, Inc., Post Office Box 10022, Birmingham, Alabama 35202.