<PAGE>   1

                     U.S. SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549
                                   FORM 10-KSB

(Mark One)

[X]      ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES 
         EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 1998         
                                       OR
[ ]      TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES 
         EXCHANGE ACT OF 1934

For the transition period from                to               
                               --------------    --------------
                                                 
Commission file number    1-12707                  
                       -------------

                            PINNACLE BANCSHARES, INC.
                            -------------------------
                 (Name of small business issuer in its charter)


           Delaware                                      72-1370314        
-------------------------------             ------------------------------------
(State or other jurisdiction of             (I.R.S. Employer Identification No.)
incorporation or organization)

1811 Second Avenue, Jasper,  Alabama                     35502-1388  
-------------------------------------       ------------------------------------
(Address of principal executive offices)    (Zip Code)

         Issuer's telephone number, including area code: (205) 221-4111.

           Securities registered pursuant to Section 12(b) of the Act:

                                                    Name of Each Exchange
         Title of Each Class                         on Which Registered 
---------------------------------------     ------------------------------------
 Common Stock, par value $.01 per share            American Stock Exchange

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

Check whether the issuer (1) has filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such
shorter period that the registrant was required to file such reports), and (2)
has been subject to such filing requirements for the past 90 days. YES X  NO
                                                                      ---   ---

Check if disclosure of delinquent filers in response to Item 405 of Regulation
S-B is not contained in this form, and no disclosure will be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-KSB or any amendment to
this Form 10-KSB. [X]

State issuer's revenues for its most recent fiscal year,  $16,981,541.

The aggregate market value of the voting stock held by non-affiliates, computed
by reference to the price ($9.375 per share) at which the Common Stock was sold
on March 31, 1999, was approximately $15,366,769. For purposes of this
calculation, the term "affiliate" refers to all executive officers and directors
of the registrant and all stockholders beneficially owning more than 10% of the
registrant's Common Stock.

As of the close of business on March 31, 1999, 1,789,586 shares of the
registrant's Common Stock were outstanding.

Transitional Small Business Disclosure Format:  YES    NO X
                                                   ---   ---

                       Documents Incorporated By Reference
Part II:
Annual Report to Stockholders for the year ended December 31, 1998.

Part III:
Portions of the definitive proxy statement for the 1999 Annual Meeting of
Stockholders.


<PAGE>   2

                                     PART I

ITEM 1.  DESCRIPTION OF BUSINESS

GENERAL

         THE HOLDING COMPANY. Pinnacle Bancshares, Inc. (the "Holding Company")
is a bank holding company incorporated under the laws of the State of Delaware.
The Holding Company is registered under the Bank Holding Company Act of 1956, as
amended (the "Holding Company Act"). The Holding Company is the holding company
for Pinnacle Bank (the "Bank"), which was chartered by the State of Alabama and
acquired by the Holding Company on January 31, 1997.

         The Holding Company's executive offices and the main office of the Bank
are located at 1811 Second Avenue, Jasper, Alabama 35502. The Holding Company's
telephone number is (205) 221-4111.

         THE BANK. The Bank is an Alabama-chartered commercial bank with five
offices located in Central and Northwest Alabama. The Bank was originally
chartered as First Federal Savings and Loan Association of Jasper in 1935, and
since that time its accounts have been federally insured. The Bank converted
from a federal stock savings bank to an Alabama-chartered commercial bank on
January 31, 1997 in connection with the holding company reorganization. The Bank
has its main office at 1811 Second Avenue, Jasper, Alabama, and also has a
branch office in Jasper, Alabama, with other branch offices in Sumiton,
Haleyville, and Birmingham, Alabama.

         The Bank is primarily engaged in the business of obtaining funds in the
form of savings deposits and investing such funds in mortgage loans on
single-family residential real estate. To a lesser extent the Bank is engaged in
making consumer loans, commercial real estate loans, and other commercial loans.

         The principal sources of funds for the Bank's lending activities are
savings deposits, Federal Home Loan Bank ("FHLB") of Atlanta advances, principal
repayments of loans and sales of loans. The Bank's principal sources of income
are interest on loans, servicing and commitment fees, and interest and dividends
on securities. Its principal expenses are interest on savings accounts and
borrowings, and general and administrative expenses.



                                       2
<PAGE>   3

SELECTED FINANCIAL AND OTHER DATA

         The following data should be read in conjunction with the consolidated
financial statements and accompanying notes thereto, and other financial
information included elsewhere herein.

<TABLE>
<CAPTION>
                                                                 At December 31,
                                                           ---------------------------
                                                               1997           1998
                                                               ----           ----
                                                              (Dollars in thousands)

<S>                                                        <C>            <C> 
FINANCIAL CONDITION AND OTHER DATA:
Total amount of:
   Assets............................................      $  201,949     $  218,086
   Loans, net........................................         137,676        128,962
   Interest-bearing deposits in other banks..........           4,873         30,845
   Securities........................................          44,423         40,415
   Loans held for sale...............................           1,857          2,986
   Deposits..........................................         179,377        194,687
   Borrowed funds....................................           3,640          3,520
   Stockholders' equity..............................          16,781         17,612

Number of:
   Real estate loans outstanding.....................           3,994          3,589
   Savings accounts..................................          16,365         16,136
   Full service offices open.........................               5              6
</TABLE>

<TABLE>
<CAPTION>
                                                                           Year Ended December 31,
                                                           -------------------------------------------------------
                                                                 1996               1997                1998
                                                                 ----               ----                ----
                                                                               (In Thousands)

<S>                                                        <C>                <C>                 <C>
OPERATING DATA:
Interest revenue....................................       $     14,680       $     15,858        $     15,921
Interest expense....................................              8,443              8,903               9,251
                                                           ------------       ------------        ------------
Net interest income before provision for losses
   on loans.........................................              6,237              6,955               6,670
Provision for losses on loans.......................                265                400                 637
                                                           ------------       ------------        ------------
Net interest income after provision for losses                                                     
   on loans.........................................              5,972              6,555               6,033
Noninterest income..................................              1,334              1,359               1,060
Noninterest expense.................................              5,709              4,663               4,813
Income tax expense..................................                613              1,188                 778
                                                           ------------       ------------        ------------
Net earnings........................................       $        984       $      2,063        $      1,502
                                                           ============       ============        ============
</TABLE>



                                       3
<PAGE>   4

         The following table sets forth certain information relating to the
Bank's average interest-earning assets and interest-bearing liabilities and
reflects the average yield on assets and average cost of liabilities for the
periods indicated. Such yields and costs are derived by dividing income or
expense by the average monthly balance of assets or liabilities, respectively,
for the periods presented. During the periods indicated, non-accruing loans, if
any, are included in the net loan category. Average balances are derived from
month-end average balances. Management does not believe that the use of
month-end average balances instead of average daily balances has caused any
material difference in the information presented.

<TABLE>
<CAPTION>
                                                                      For the Years Ended December 31,
                                            ------------------------------------------------------------------------------------
                                                             1997                                         1998
                                            ----------------------------------------    ----------------------------------------
                                              Average                  Average            Average                    Average
                                              Balance      Interest   Yield/Cost          Balance       Interest    Yield/Cost
                                              -------      --------   ----------          -------       --------    ----------

<S>                                         <C>           <C>         <C>               <C>           <C>           <C>
Interest-earning assets:
Loans receivable, net.................      $  137,868    $  12,546          9.1%       $  135,254    $   12,217           9.0%
Securities available for sale.........          46,031        2,992          6.5%           42,546         2,718           6.4%
Other.................................           5,544          320          5.8%           18,296           986           5.4%
                                            ----------    ---------                     ----------    ----------     ---------
Total.................................      $  189,443    $  15,858          8.4%          196,096    $   15,921           8.1%
Non-interest-earning assets...........          11,237                                      13,613     
                                            ----------                                  ----------
Total assets..........................      $  200,680                                  $  209,709
                                            ==========                                  ==========
Interest-bearing liabilities:
Deposits..............................      $  177,319        8,696          4.9%       $  185,944         9,049           4.9%
Borrowings............................           3,658          207          5.7%            3,539           205           5.8%
                                            ----------    ---------                     ----------    ----------
Total interest-bearing liabilities:...         180,977        8,903          4.9%          189,483         9,254           4.9%
Non-interest-bearing liabilities......           3,416                                       2,742
                                            ----------                                  ----------
Total Liabilities:....................         184,393                                     192,225
   Equity.............................          16,287                                      17,454
                                            ----------                                  ----------
   Total Liabilities and Equity.......      $  200,680                                  $  209,679
                                            ==========                                  ==========
Net interest-earning assets...........                        8,466                                        6,613
                                                          ---------                                   ----------
Net interest income...................                    $   6,955                                   $    6,667
                                                          =========                                   ==========
Interest rate spread..................                                       3.5%                                          3.2%
                                                                      ==========                                    ==========
Net interest margin...................                                       3.7%                                          3.4%
                                                                      ==========                                    ==========
Ratio of average interest-earning 
   assets to interest-bearing
   liabilities........................
                                                                           104.7%                                        103.5%
                                                                      ==========                                    ==========
</TABLE>



                                       4
<PAGE>   5

LENDING ACTIVITIES

         GENERAL. The Bank's net loan portfolio totaled $129.0 million at
December 31, 1998, or 59.1% of its total assets. On that date, $108.0 million,
or 8.4% of total net loans outstanding, consisted of loans secured by mortgages
on single family, two-to-four family, multi-family residential properties, and
commercial real estate loans, while the remainder of the loan portfolio
consisted of savings account, home improvement and other consumer and commercial
loans.

         The principal lending activity of the Bank historically has been the
origination of conventional first mortgage single-family loans. The Bank also
makes loans on two-to-four family dwelling units, multi-family dwelling units,
commercial real estate and other improved real estate. The majority of the
Bank's loans have been originated within its primary market area.

         During the year ended December 31, 1997, the Bank repaid approximately
$110,000 in borrowed funds with the proceeds from maturing investment
securities, increases in savings deposits, and loan repayments. The Bank funded
loan demands with the proceeds from loan repayments, increases in savings
deposits and maturing securities. The Bank borrowed funds on a short-term basis
from the FHLB of Atlanta. However, there were no short-term borrowings
outstanding at December 31, 1997. During the year ended December 31, 1998, the
Bank funded loan demands with increases in savings deposits and the proceeds
from loan repayments. The Bank did not increase borrowings during the year ended
December 31, 1998.

         The Bank had no securities classified as held to maturity as of
December 31, 1998. See Note 1 of Notes to Consolidated Financial Statements.

         The Bank's volume of total loans originated to be retained in the
Bank's loan portfolio totaled approximately $93.4 million during the year ended
December 31, 1997, and $89.6 million during the year ended December 31, 1998.
The Bank directly originates most of its mortgage loans through its existing
branches. These loans have been originated predominantly within the Bank's
geographical lending area of Walker, Jefferson, Shelby, Winston and Fayette
counties, in Alabama. See " -- Loan Solicitation and Processing" and "-- Loan
Originations, Purchases and Sales."

         The Bank seeks to improve the interest rate sensitivity of its mortgage
loan portfolio through the origination of adjustable rate loans, which
constituted approximately 47.1% of the single family residential mortgage loans
in the Bank's loan portfolio, and 31.4% of the Bank's net loan portfolio at
December 31, 1998. Most adjustable rate mortgage loans are held in the Bank's
loan portfolio, while most fixed-rate mortgage loans are either sold as
whole-loans to the Federal Home Loan Mortgage Corporation ("FHLMC") or the
Federal National Mortgage Association ("FNMA") or other investors, or converted
into mortgage-backed securities with servicing retained by the Bank.



                                       5
<PAGE>   6

         The following table sets forth, in dollar amounts and percentages, the
major categories of the Bank's loans. At December 31, 1998, the Bank had no
concentrations of loans exceeding 10% of gross losses other than as described
below.

<TABLE>
<CAPTION>
                                                     December 31,
                                     ---------------------------------------------
                                             1997                     1998
                                     -------------------      --------------------      
                                           $         %              $          %
                                          ---       ---            ---        ---
                                                (Dollars in thousands)

<S>                                  <C>         <C>          <C>         <C> 
Type of Loan:
Real estate mortgage loans......     $   94,317     68.5%     $   86,956      67.4%
Construction loans..............         30,746     22.3%         32,263      25.0%
Commercial loans................         14,299     10.4%         12,248       9.5%
Consumer loans..................          8,845      6.4%         10,069       7.8%
Less --
   Loans in process.............          9,083      6.6%         11,143       8.6%
   Discounts and other..........            214      0.2%            231       0.2%
   Allowance for loan losses....          1,234       .9%          1,201       0.9%
                                     ----------  -------      ----------  --------
     Total......................     $  137,676    100.0%     $  128,961    100.00%
                                     ==========  =======      ==========  ========
</TABLE>

         RESIDENTIAL LOANS. The primary lending activity of the Bank has been
the granting of conventional mortgage loans to enable borrowers to purchase
existing homes or construct new homes. The Bank's real estate loan portfolio
also includes loans on two-to-four family dwellings, multi-family housing (over
four units), and loans made for the development of unimproved real estate to be
used for residential housing. At December 31, 1998, approximately 82% of the
Bank's total real estate loan portfolio consisted of loans secured by
residential real estate.

         The loan-to-value ratio, maturity and other provisions of the loans
made by the Bank generally have reflected the policy of making less than the
maximum loan permissible under applicable regulations, in accordance with sound
lending practices, market conditions, and underwriting standards established by
the Bank. Mortgage loans made by the Bank are generally long-term loans,
amortized on a monthly basis, with principal and interest due each month. The
initial contractual loan payment period for residential loans typically ranges
from 15 to 30 years. Currently, the Bank offers one-year, adjustable rate loans
based upon the one-year U.S. Treasury Bill rate adjusted to a constant maturity,
with limitations on adjustments of 2% in any one year and 6% over the life of
the loan.

         At December 31, 1998, the largest amount loaned by the Bank to one
borrower was $2.7 million which was approximately 15% of the Holding Company's
stockholders' equity.

         COMMERCIAL REAL ESTATE AND CONSTRUCTION LOANS. Construction loans on
residential properties are made primarily to individuals. The maximum loan to
value ratio is 80% of either the appraisal or the purchase price, whichever is
lower. Residential construction loans are typically made for periods of six
months. At December 31, 1998, the Bank had $27.1 million outstanding in
residential construction loans, compared with $28.2 million in construction
loans on residential properties outstanding at December 31, 1997.

         The Bank has historically originated commercial real estate loans
within its primary market area. The Bank either funded or purchased
participation interests in various large commercial real estate projects, one of
which was outside of its primary market area. See " -- Non-Performing Loans and
Asset Classification" and "Subsidiary Activities." Since 1984, the Bank has
limited its commercial real estate lending activities to smaller commercial real
estate projects located in its primary market area, with the amount loaned
limited to 10% of its net worth. See "-- Nonperforming Loans and Asset
Classification" and "Subsidiary Activities." At December 31, 1998, the Bank had
$26.9 million outstanding in commercial real estate loans, including $5.2
million in commercial construction loans. These loans are typically limited to
owner-occupied financings.

         COMMERCIAL BUSINESS LOANS. At December 31, 1998, there were
approximately $12.2 million in commercial loans outstanding. The Bank will
consider making these types of loans in its local market area.



                                       6
<PAGE>   7

         CONSUMER LOANS. The Bank makes various types of consumer loans,
including the loans made to depositors on the security of their savings
accounts, personal loans, automobile loans, educational loans and loans for home
improvement or other purposes. At December 31, 1998, the Bank had $10.1 million
outstanding in consumer loans.

         LOAN SOLICITATION AND PROCESSING. Loan originations come from a
combination of walk-in customers and real estate brokers.

         For additional information on the Bank's lending activities, see Note 3
of Notes to Consolidated Financial Statements.

         LOAN ORIGINATIONS, PURCHASES AND SALES. The Bank has engaged in selling
in the secondary market certain loans it has originated. Such loans sold are
generally fixed-rate, long-term mortgage loans. These sales, the majority of
which do not allow recourse to the Bank, have been made to FHLMC and FNMA, which
purchases residential mortgage loans from federally insured financial
institutions and certain other lenders. Many of the Bank's loans have been
exchanged for FHLMC participation certificates ("PCs") or FNMA mortgage-backed
securities. These PCs or mortgage-backed securities are generally considered to
be a more liquid form of asset and are a more widely accepted form of collateral
than the underlying loans.

         The sale of loans in the secondary mortgage market reduces the Bank's
risk that the interest rates it pays will escalate while holding long-term,
fixed-rate loans in its portfolio and allows the Bank to continue to make loans
during periods when savings flows decline or funds are not otherwise available
for lending purposes. In connection with such sales the Bank provides servicing
on the loans (i.e., collection of principal and interest payments) for which it
receives a fee payable monthly of 1/4% to 3/8% per annum of the unpaid balance
of each loan. These loan sales will continue as the Bank attempts to maintain
its loan servicing base. As of December 31, 1998, the Bank was servicing loans
for others aggregating approximately $79.4 million. Net servicing income for the
years ended December 31, 1997 and 1998 was approximately $237,000 and $214,000,
respectively.

         The Bank is continuously selling loans in the secondary market. During
the years ended December 31, 1997 and 1998, the Bank sold in excess of $33.0
million and $59.0 million, respectively, in whole loans. As of December 31,
1998, the Bank had $2.7 million in commitments outstanding to package or sell
additional loans.

         The Bank's loan policy requires that the Bank's loan committee
identify, at the beginning of each quarter, loans which will be held for the
portfolio and loans which will be held for sale. Loans that are designated to be
held for the portfolio may be sold only in unusual circumstances which could not
be reasonably anticipated at the time of their origination or purchase. Loans
held for sale are carried at the lower of cost or market value and are sold as
soon as possible after their origination, as market conditions allow.

         LOAN COMMITMENTS. The Bank issues commitments to prospective borrowers
to make loans conditioned upon the occurrence of certain events. Such
commitments are made on specific terms and conditions, and are honored for 60
days from approval with no additional fees required. The Bank charges a
non-refundable commitment fee equal to 1% of the actual amount of committed
funds on all single-family construction loans. The Bank had outstanding
commitments to originate mortgage loans aggregating $19.9 million at December
31, 1998. Of these commitments, $18.5 million were for adjustable rate mortgages
and $1.4 million were for fixed rate mortgages.

         Although the Bank originates most fixed-rate loans for resale in the
secondary mortgage market, a certain amount of interest rate risk exists for the
Bank after a loan is closed until a loan is sold.

         LOAN ORIGINATION AND OTHER FEES. In addition to interest earned on
loans, the Bank receives loan origination fees or "points" for originating
loans. Loan points are a percentage of the principal amount of the mortgage loan
which are charged to the borrower for creation of the loan. The Bank accounts
for loan origination fees net of direct costs as a yield adjustment over the
life of the loan. See Note 1 of Notes to Consolidated Financial Statements.



                                       7
<PAGE>   8

         MATURITY OF LOAN PORTFOLIO. The following table sets forth certain
information at December 31, 1998 regarding the dollar amount of loans maturing
in the Bank's portfolio based on their contractual terms to maturity. Demand
loans, loans having no schedule of repayments and no stated maturity and
overdrafts are reported as due in one year or less. The Bank does not have any
loans with no stated schedule of repayments and no stated maturity.

<TABLE>
<CAPTION>
                                                          Due After One Through        Due After
                                         Due by             Five Years After       Five Years After
                                   December 31, 1999        December 31, 1998      December 31, 1998          Total
                                   -----------------        -----------------      -----------------          -----

<S>                                <C>                    <C>                      <C>                   <C> 
Real estate mortgage...........       $  8,173,696             $ 29,814,189           $ 50,522,654       $  88,510,539
Real estate construction.......         21,119,594                       --                                 21,119,594
Commercial business loans......          6,213,149                3,622,532              2,412,110          12,247,791
Consumer.......................          3,325,497                6,511,553                232,365          10,069,415
                                      ------------             ------------           ------------       -------------
   Total.......................       $ 38,831,936             $ 39,948,274           $ 53,167,129       $ 131,947,339
                                      ============             ============           ============       =============
</TABLE>

         The following table sets forth the dollar amount of all loans due after
one year at December 31, 1998 which have predetermined interest rates and have
floating or adjustable interest rates.

<TABLE>
<CAPTION>
                                                                              Floating or               Adjustable
                                                                         Predetermined Rates               Rates
                                                                         -------------------               -----

                         <S>                                             <C>                         <C> 
                         Real estate mortgage......................         $   41,495,757           $   38,841,086
                         Commercial business loans.................              2,425,176                3,609,466
                         Consumer..................................              6,649,389                   94,529
                                                                            --------------           --------------
                           Total...................................         $   50,570,322           $   42,545,081
                                                                            ==============           ==============
</TABLE>

         NON-PERFORMING LOANS AND ASSET CLASSIFICATION. Loans that are 120 days
contractually past due are placed on nonaccrual status and interest income is
reversed. Income is subsequently recognized only to the extent that cash
payments are received until, in management's judgment, the borrower's ability to
make periodic interest and principal payments is back to normal, in which case
the loan is returned to accrual status.

         Real estate acquired by the Bank as a result of foreclosure or by deed
in lieu of foreclosure is classified as real estate owned until such time as it
is sold. When such property is acquired it is recorded at the lower of the
unpaid principal balance of the related loan or its fair value less estimated
costs of disposition. Any write-down of the property at foreclosure is charged
to the allowance for loan losses. Future declines in fair value of the asset
less costs of disposition below its carrying amount increases the valuation
allowance account. Future increases in fair value of the asset less costs of
disposition above its carrying amount reduces the valuation allowance account,
but not below zero. Increases or decreases in the valuation allowance account is
charged or credited to income. Costs relating to the development and improvement
of property are capitalized, whereas costs relating to the holding of property
are expensed.

         The recognition of gains and losses on the sale of real estate is
dependent upon whether the nature and terms of the sale and future involvement
of the Bank in the property meet certain requirements. If the transaction does
not meet these requirements, income recognition is deferred and recognized under
an alternative method in accordance with Statement of Financial Accounting
Standards ("SFAS") No. 66 -- "Accounting for Sales of Real Estate."



                                       8
<PAGE>   9

         The following table sets forth information with respect to the Bank's
non-performing assets for the periods indicated.

<TABLE>
<CAPTION>
                                                                At December 31,
                                                       ---------------------------------
                                                           1997                 1998
                                                           ----                 ----
                                                             (Dollars in thousands)

<S>                                                    <C>                  <C>
Loans accounted for on a nonaccrual basis: (1)
Real Estate:
   Residential...................................      $        542         $        521
   Commercial....................................             1,393                  610
Consumer.........................................                97                   87
                                                       ------------         ------------
Total............................................      $      2,032         $      1,218
                                                       ============          ===========

Accruing loans which are contractually 
  past due 90 days or more:
Real Estate:
   Residential...................................      $         --         $      2,915
   Commercial....................................                --                  656
Consumer.........................................                --                   --
                                                       ------------         ------------
Total............................................      $         --         $      3,571
                                                       ============         ============
   Total of nonaccrual and 90 days
     past due loans..............................      $      2,032         $      4,789
                                                       ============         ============

Percentage of total loans........................              1.48%                3.71%

Percentage of total assets.......................              1.01%                2.20%

Other non-performing assets(2)...................      $      2,140         $      2,175
</TABLE>

-------------
(1)  Nonaccrual status denotes loans on which accrual of interest has been
     ceased in accordance with the guidelines discussed above. Payments received
     on a nonaccrual loan are either applied to the outstanding principal
     balance or recorded as interest income, depending on assessment of the
     collectibility of the loan.
(2)  Other non-performing assets represent property acquired by the Bank through
     foreclosure or repossession. The property is carried at the lower of its
     fair value less estimated costs of disposition or the investment balance of
     the related loan, whichever is lower.

         Management has identified certain loans aggregating approximately $4.4
million at December 31, 1998 (including loans identified in the above table)
which it has determined require special attention due to potential weaknesses.
It is management's opinion that the allowance for loan losses (see below) is
adequate to absorb potential losses related to such loans. Aggressive efforts to
continue to reduce principal, secure additional collateral and improve the
overall payment status of their loans.

         During the years ended December 31, 1997 and 1998 gross interest income
of $47,208 and $48,845, respectively, would have been recorded on loans
accounted for on a nonaccrual basis if the loans had been current throughout the
period. The amount of interest income included in current income for these loans
was $52,258 and $9,078 for the years ended December 31, 1997 and 1998,
respectively.

         It is management's policy to establish an allowance for estimated
losses on loans and real estate owned based upon prior experience, current
economic conditions in its market area, or when it determines that losses are
expected to be incurred on the ultimate disposition of the underlying
properties. Although management believes that it uses the best information
available to make such determinations, future adjustments to allowances may be
necessary, and net earnings could be significantly affected if circumstances
differ substantially from the assumptions used in making the initial
determinations.



                                       9
<PAGE>   10

         The following table presents an allocation of the allowance for
possible loan losses by the categories indicated and the percentage that all
loans in the category bear to total loans. This allocation is used by management
to qualify its evaluation of the loan portfolio. Allocations are merely
estimates and are subject to revisions as conditions change.

<TABLE>
<CAPTION>
                                                     At December 31,
                                   --------------------------------------------------
                                             1997                       1998
                                   -----------------------     ----------------------
                                              Percent of                 Percent of
                                             Loans in Each              Loans in Each
                                              Category to                Category to
                                     Amount   Total Loans       Amount   Total Loans
                                     ------   -----------       ------   -----------
                                                 (Dollars in thousands)

<S>                                <C>       <C>               <C>      <C>  
Real estate loans............      $      540      83.7%       $     618      83.7%
Commercial...................             199      10.1%             123      10.1%
Other loans..................             256       6.2%             251       6.2%
Unallocated..................             239         0%             209         0%
                                   ----------   -------        ---------   -------
   Total.....................      $    1,234     100.0%       $   1,201     100.0%
                                   ==========   =======        =========   =======
</TABLE>

         The following table sets forth an analysis of the Bank's allowance for
possible loan losses for the periods indicated.

<TABLE>
<CAPTION>
                                                    Year Ended December 31,
                                                 -----------------------------
                                                     1997              1998
                                                     ----              ----
                                                     (Dollars in thousands)

<S>                                              <C>               <C>
Balance at beginning of period............       $     1,197       $     1,234
                                                 -----------       -----------

Loans charged-off:
   Consumer...............................               129                67
   Mortgage...............................               298               651
                                                 -----------       -----------

Total charge-offs.........................               427               718
                                                 -----------       -----------

Total recoveries..........................                64                48
                                                 -----------       -----------

Net loans charged-off.....................               363               670
                                                 -----------       -----------

Provision for possible loan losses........               400               637
                                                 -----------       -----------

Balance at end of period..................       $     1,234       $     1,201
                                                 ===========       ===========

Ratio of net charge-offs to average
   loans outstanding during the period....               .26%              .53%
                                                 ===========       ===========
</TABLE>

         For further information and for an analysis of the Bank's allowances
for loan and real estate losses, see Notes 3 and 5 of Notes to Consolidated
Financial Statements.

INVESTMENT ACTIVITIES

         Interest income from cash deposits and securities generally provide the
second largest source of income for the Bank after interest on loans and loan
servicing fees and other fees. At December 31, 1998, the Bank's interest-bearing
deposits and securities portfolio of approximately $40.4 million, excluding
mortgage-backed securities, consisted primarily of interest-bearing bank
deposits, U.S. government and agency obligations, corporate securities, and FHLB
of Atlanta stock.



                                       10
<PAGE>   11

         It has generally been the Bank's policy to maintain a liquidity
portfolio in excess of regulatory requirements in order to shorten the
maturities of the Bank's investment portfolio to enable the Bank to better match
its short-term investments and interest rate sensitive savings deposit
liabilities. The Bank also increases its liquidity by selling most of its fixed
rate loans with maturities of greater than 10 years.

         Securities are classified as either trading, available for sale or held
to maturity based on management's intent and ability. See Note 1 of Notes to
Consolidated Financial Statements.

         The following table sets forth the carrying value of the Bank's
investment securities and mortgage-backed securities at the dates indicated.

<TABLE>
<CAPTION>
                                                                At December 31,
                                                       --------------------------------
                                                            1997                1998
                                                            ----                ----
                                                                 (In thousands)

<S>                                                    <C>                 <C>
Securities available for sale:
   U.S. Treasury securities......................      $     12,038        $      4,027
   U.S. Government and agency securities.........             9,017              17,996
   FHLB stock....................................             1,520               1,473
   Mortgage-backed securities....................            21,641              16,877
   Other securities..............................               207                  42
                                                       ------------        ------------
Total............................................      $     44,423        $     40,415
                                                       ============        ============
</TABLE>

         The following table sets forth the scheduled maturities, amortized
cost, fair values and weighted average yields for the Bank's securities
available for sale at December 31, 1998.

<TABLE>
<CAPTION>
                                          One Year Or Less      After One Through Five Years  After Five Through Ten Years       
                                      ------------------------  ----------------------------  ----------------------------         
                                      Amortized     Weighted      Amortized      Weighted      Amortized      Weighted            
                                         Cost    Average Yield       Cost     Average Yield       Cost     Average Yield          
                                         ----    -------------       ----     -------------       ----     -------------          
                                                                     (Dollars in thousands)

<S>                                   <C>        <C>              <C>         <C>              <C>         <C>
U.S. Treasury securities .....         $ 4,009        4.7%          $    --         --%          $    --        --%               
U.S. government and agency....           1,007        7.7            17,000        5.9                --        --                
FHLB of Atlanta stock(1) .....           1,473        7.3                --         --                --        --                
Other securities(2) ..........              --         --                --         --                41        --                
Mortgage-backed securities....              --         --                --         --             3,600       6.9%               
                                       -------        ---           -------        ---           -------       ---                
Total ........................         $ 6,489        5.8%          $17,000        5.9%          $ 3,641       6.9%               
                                       =======        ===           =======        ===           =======       ===   

<CAPTION>

                                          After Ten Years       
                                      ------------------------    Total
                                      Amortized     Weighted    Amortized                    Weighted
                                         Cost    Average Yield     Cost       Fair Value  Average Yield
                                         ----    -------------     ----       ----------  -------------
                                                          (Dollars in thousands)

<S>                                   <C>        <C>            <C>           <C>         <C> 
U.S. Treasury securities......         $    --           %       $ 4,009        $ 4,027        4.7%     
U.S. government and agency....              --         --         18,007         17,996        6.0   
FHLB of Atlanta stock(1)......                                     1,473          1,473        7.3   
Other securities(2)...........              --         --             42             42         --   
Mortgage-backed securities....          13,237        6.9%        16,837         16,877        6.9   
                                       -------        ---        -------        -------        ---   
Total.........................         $13,237        6.9%       $40,368        $40,415        6.3%  
                                       =======        ===        =======        =======        ===  
</TABLE>
 
---------------
(1)  FHLB of Atlanta stock is an equity security. The amount of such stock held
     by the Bank is included under "After Ten Years" as the Bank is required to
     hold such stock as a FHLB of Atlanta member.
 (2) Other securities includes the Bank's investment in limited partnerships, at
     cost, of $40,138 whose sole purpose is to hold and operate real estate. The
     Bank has no loans to these real estate partnerships. These investments are
     not readily marketable.



                                       11
<PAGE>   12

SUBSIDIARY ACTIVITIES

         FIRST GENERAL SERVICE(S) CORPORATION. First General Service(s)
Corporation ("First General") was incorporated in August 1978, for the purpose
of having an ownership interest in Savings and Loan Data Corporation,
Cincinnati, Ohio, which provided on-line computer services to the Bank.

         In 1984, First General established an office at 407-9th Avenue in
Jasper, Alabama. At the same time, four employees from the Bank were transferred
to First General for the purpose of servicing the Bank's loans. The scope of
First General's activities included servicing, auditing and quality control of
all loans originated by the Bank and by First General's 40% owned subsidiary,
First General Lending Corporation. In 1990, all employees of First General, and
property and equipment relating to loan servicing, were transferred to the Bank.
At December 31, 1998, First General had a total equity investment of $1,715 in
First General Insurance Agency.

         FIRST GENERAL VENTURES CORPORATION. As of December 31, 1998, First
General Ventures Corporation had a total investment in joint ventures of
$40,138. The Bank believes that the market value of these investments is in
excess of the book values. The assets of First General Land Corporation, one of
the Bank's wholly-owned subsidiaries, were transferred to First General Ventures
Corporation. First General Land Corporation was dissolved. As of December 31,
1998, the Bank had no loan commitments and does not presently intend to make
loans to these joint ventures.

SOURCES OF FUNDS

         GENERAL. Deposits are the major source of the Bank's funds for lending
and other investment purposes. In addition to deposits, The Bank derives funds
from loan principal repayments, advances from the FHLB of Atlanta and other
borrowings. Loan repayments are a relatively stable source of funds, while
deposit inflows and outflows are significantly influenced by general interest
rates and money market conditions. Borrowings may be used on a short term basis
to compensate for reductions in the availability of other sources of funds. They
may also be used on a longer term basis for general business purposes.

         DEPOSITS. Consumer and commercial deposits are attracted principally
from within the Bank's primary market area through the offering of a broad
selection of deposit instruments including NOW accounts, non-interest bearing
demand deposit accounts, money market accounts, regular savings accounts, term
certificate accounts and retirement savings plans. Deposit account terms vary,
with the principal differences being the minimum balance required, the amount of
time the funds must remain on deposit and the interest rate.

         The Bank offers a full range of accounts including: passbook, money
market, checking, individual retirement accounts ("IRAs") and certificate
accounts. The deregulation of various federal controls on insured deposits has
allowed the Bank to be more competitive in obtaining funds and given it more
flexibility to alleviate the risk of net deposit outflows. While the
deregulation of rates payable on deposits has allowed the Bank to be competitive
in the acquisition and retention of funds, it has also resulted in a more
volatile cost of funds.

         Interest rates paid, maturity terms, service fees and withdrawal
penalties are established by the Bank on a weekly basis. Determination of rates
and terms are predicated on funds acquisition and liquidity requirements, rates
paid by competitors, growth goals, and federal regulations.

         Marketing of the Bank's savings programs takes a number of different
forms. All branch offices are provided with brochures which outline the rates
and features of the Bank's various accounts. The Bank already offers most of the
services provided by other savings and loans. These services include consumer
and commercial loans, limited lines of credit, all types of checking and deposit
accounts, and IRAs.

         As of December 31, 1998, the Bank's total deposits were $194.7 million.



                                       12
<PAGE>   13

         The following table indicates the amount of the Bank's certificates of
deposit and other time deposits of $100,000 or more by time remaining until
maturity as of December 31, 1997.

<TABLE>
<CAPTION>
                                                                     Certificates
                Maturity Period                                       of Deposit
                ---------------                                       ----------
                                                                    (In thousands)

                <S>                                                 <C> 
                Three months or less........................         $     19,272
                Over three through six months...............                6,195
                Over six through twelve months..............                9,610
                Over twelve months..........................               10,699
                                                                     ------------
                  Total.....................................         $     45,776
                                                                     ============
</TABLE>

         The following table sets forth the average balances and average
interest rates based on daily balances for deposits for the periods indicated.

<TABLE>
<CAPTION>
                                                                      Year Ended December 31,
                                                      ------------------------------------------------------
                                                               1997                            1998
                                                      -----------------------         ----------------------
                                                        Average       Average           Average      Average
                                                        Deposits       Rate             Deposits      Rate
                                                        --------       ----             --------      ----
                                                                      (Dollars in thousands)
<S>                                                   <C>             <C>             <C>            <C> 
Non-interest bearing demand deposits............      $      5,168         --%        $      7,342        --%
Interest bearing demand deposits................            23,672        3.1               23,670       3.0
Savings deposits................................            16,484        2.7               15,727       2.7
Time deposits...................................           131,995        5.7              139,205       5.7
                                                      ------------    -------         ------------    ------
   Total deposits...............................      $    177,319        4.9%        $    185,944       4.9%
                                                      ============    =======         ============    ======
</TABLE>



                                       13
<PAGE>   14

         For further information, see Note 6 of Notes to Consolidated Financial
Statements.

         BORROWINGS. The Bank relies upon deposits and loan repayments and sales
as its major sources of funds. However, the Bank makes use of FHLB advances to
expand its lending and short-term investment activities and to meet depositor
withdrawals. Advances have been used to supplement deposit flows and are
particularly used when the Bank determines that it can profitably invest the
advances over their term.

         As disclosed in the following table, the Bank had no short-term
borrowings at the dates and for the periods indicated:

<TABLE>
<CAPTION>
                                                                At or for the
                                                           Year Ended December 31,
                                                           -----------------------
                                                              1997         1998
                                                              ----         ----
                                                            (Dollars in thousands)

<S>                                                         <C>          <C>
Amounts outstanding at end of period:
   FHLB of Atlanta advances..........................       $     --     $     --
Weighted average rate paid at period end:
   FHLB advances.....................................             --%          --%

Maximum amount of borrowings outstanding at any 
   month end:
   FHLB advances.....................................       $     --     $     --

Approximate average amounts outstanding for period:
   FHLB advances.....................................       $     --     $     --
Approximate weighted average rate paid during
   period (1):
   FHLB advances.....................................             --%          --%
</TABLE>

--------------
(1)  The approximate weighted average rate paid during the period was computed
     by dividing the average amounts outstanding into the related interest
     expense for the period.

         For further information on the Bank's borrowings, see Note 7 of Notes
to Consolidated Financial Statements.

SELECTED FINANCIAL RATIOS

         The following table sets forth selected financial ratios of the Bank
for the periods indicated:

<TABLE>
<CAPTION>
                                                                Year Ended December 31,
                                                        --------------------------------------
                                                        1996             1997             1998
                                                        ----             ----             ----

<S>                                                     <C>              <C>              <C>
Return on Assets (Net Income Divided By
Average Total Assets) (1)...................             0.5%             1.0%             0.7%
Return on Equity (Net Income Divided By
   Average Equity) (1)......................             6.5%            12.7%             8.6%
Equity-to-Assets Ratio (Average Equity
   Divided By Average Total Assets).........             8.0%             8.1%             8.0%
Dividend Payout Ratio (Dividends
   Declared Per Share Divided By Net
   Income Per Share)........................            65.5%            34.5%            48.2%
</TABLE>

----------------
(1) Ratios have been annualized for the six-month period ended December 31,
1996.



                                       14
<PAGE>   15

LIQUIDITY AND RATE SENSITIVITY

         The following table sets forth the maturity distribution of the Bank's
interest-earning assets and interest-bearing liabilities as of December 31,
1998, the Bank's interest rate sensitivity gap (i.e., interest rate sensitive
assets less interest rate sensitive liabilities), the Bank's cumulative interest
rate sensitivity gap, the ratio of interest-earning assets to interest-bearing
liabilities, and the Bank's cumulative interest rate sensitivity gap ratio.

<TABLE>
<CAPTION>
                                                         Over One        Over Five
                                           One Year      Through          Through          Over
                                            or Less     Five Years       Ten Years       Ten Years         Total
                                            -------     ----------       ---------       ---------         -----
                                                                       (In thousands)

<S>                                      <C>            <C>             <C>             <C>             <C> 
Interest-Earning Assets: (1)
   Loans..........................       $    38,833    $    39,948     $     7,925     $    45,242     $   131,948
   Securities.....................             6,491         17,005           3,676          13,243          40,415
Other assets......................            30,845             --              --              --          30,845
                                         -----------    -----------     -----------     -----------     -----------
     Total........................       $    76,169    $    56,953     $    11,601     $    58,485     $   203,208
                                         ===========    ===========     ===========     ===========     ===========

Interest-Bearing Liabilities:(2)
   Deposits.......................       $   148,630    $    43,726     $     2,331     $        --     $   194,687
   Borrowings.....................               130            825           1,100           1,665           3,520
                                         -----------    -----------     -----------     -----------     -----------
     Total........................       $   148,760    $    44,351     $     3,431     $     1,665     $   198,207
                                         ===========    ===========     ===========     ===========     ===========

Interest Sensitivity Gap..........       $   (72,591)   $    12,602     $     8,170     $    56,820     $     5,001
                                         ===========    ===========     ===========     ===========     ===========
Cumulative Interest Sensitivity
   Gap............................       $   (72,591)   $   (59,989)    $   (51,819)    $     5,001     $    10,002
                                         ===========    ===========     ===========     ===========     ===========
</TABLE>

--------------
(1)  Fixed-rate loans are distributed based on their contractual maturity
     adjusted for projected or anticipated prepayments, and variable rate loans
     are distributed based on the interest rate reset date and contractual
     maturity adjusted for prepayments. Loan run-off and repricing assumes a
     constant prepayment rate based on coupon rate and maturity.
(2)  Passbook savings and demand deposits are presented in the earliest
     repricing period since amounts in these accounts are subject to withdrawal
     on demand. Savings certificates are distributed assuming no withdrawal
     prior to maturity.



                                       15
<PAGE>   16

RATE/VOLUME ANALYSIS

         The table below sets forth certain information regarding changes in
interest income and interest expense of the Bank for the periods indicated. The
calculations are based on average month end balances during the respective
periods. For each category of interest-earning asset and interest-bearing
liability, information is provided on changes attributable to (1) changes in
volume (changes in volume multiplied by old rate) and (2) changes in rates
(change in rate multiplied by old volume). Changes in rate-volume (change in
rate multiplied by the change in volume) have been allocated to the volume and
rate changes based upon the pro-rata amount that rate and volume are to their
total change, before allocation of the rate/volume amount.

<TABLE>
<CAPTION>
                                                    Year ended December                           Year Ended December 31,
                                                       1996 vs. 1997                                   1997 vs. 1998
                                                    Increase (Decrease)                             Increase (Decrease)
                                                    -------------------                             -------------------   
                                           Volume           Rate            Total          Volume           Rate            Total
                                           ------           ----            -----          ------           ----            -----
                                                                       (In thousands)

<S>                                        <C>             <C>             <C>             <C>             <C>             <C>
Interest Income:
Loans ...............................      $   964         $   524         $ 1,488         $  (237)        $   (92)        $  (329)
Securities ..........................         (463)             54            (463)           (223)            (51)           (274)
Other interest-earning assets .......           82              17              99             686             (20)            666
                                           -------         -------         -------         -------         -------         -------
Total interest earning assets .......      $   583         $   595         $ 1,178         $   226         $  (163)        $    63
                                           =======         =======         =======         =======         =======         =======

Interest Expense:
Deposits ............................      $   543         $     7         $   550         $   399         $  (246)        $   153
Borrowed Funds ......................          (83)             (7)            (90)             (7)              5              (2)
                                           -------         -------         -------         -------         -------         -------
Total interest-bearing liabilities...      $   460         $    --         $   460         $   392         $  (241)        $   151
                                           =======         =======         =======         =======         =======         =======
</TABLE>

COMPETITION

         The Bank faces strong competition in its primary market area for the
attraction and retention of deposits and in the origination of loans. The Bank's
most direct competition for deposits has historically come from other thrift
institutions and from commercial banks located in its primary market area.
However, in recent years the Bank has had significant competition from money
market mutual funds and other sources which are not subject to federal interest
rate limitations. The Bank's competition for real estate loans comes principally
from other thrift institutions, commercial banks, mortgage banking companies,
insurance companies and other institutional lenders.

         The Bank competes for loans through the interest rates and loan fees it
charges and the efficiency and quality of the services it provides borrowers,
real estate brokers, and home builders. It competes for deposits by offering a
wide variety of accounts, convenient branch locations, tax-deferred retirement
programs, and other miscellaneous services.

REGULATION, SUPERVISION AND GOVERNMENTAL POLICY

         The following is a brief summary of certain statutes, rules and
regulations affecting the Holding Company and the Bank. A number of other
statutes and regulations have an impact on their operations. The following
summary of applicable statutes and regulations does not purport to be complete
and is qualified in its entirety by reference to such statutes and regulations.

         Bank Holding Company Regulation. The Holding Company is registered as a
bank holding company under the Holding Company Act and, as such, subject to
supervision and regulation by the Board of Governors of the Federal Reserve
System ("FRB"). A bank holding company is required to furnish to the FRB annual
and quarterly reports of its operations and to furnish such additional
information as the FRB may require pursuant to the Holding Company Act. The
Holding Company is also subject to regular examination by the FRB.



                                       16
<PAGE>   17

         Under the Holding Company Act, a bank holding company must obtain the
prior approval of the FRB before (i) acquiring direct or indirect ownership or
control of any voting shares of any bank or bank holding company if, after such
acquisition, the bank holding company would directly or indirectly own or
control more than 5% of such shares; (2) acquiring all or substantially all of
the assets of another bank or bank holding company; or (3) merging or
consolidating with another bank holding company.

         The Holding Company Act, as amended by the Riegle-Neal Act, generally
permits the FRB to approve interstate bank acquisitions by bank holding
companies without regard to any prohibitions of state law. See "Competition".

         Under the Holding Company Act, any company must obtain approval of the
FRB prior to acquiring control of the Holding Company or the Bank. For purposes
of the Holding Company Act, "control" is defined as ownership of more than 25%
of any class of voting securities of the Holding Company or the Bank, the
ability to control the election of a majority of the directors, or the exercise
of a controlling influence over management or policies of the Holding Company or
the Bank.

         The Change in Bank Control Act and the regulations of the FRB
thereunder require any person or persons acting in concert (except for companies
required to make application under the Holding Company Act), to file a written
notice with the FRB before such person or persons may acquire control of the
Holding Company the Bank. The Change in Bank Control Act defines "control" as
the power, directly or indirectly, to vote 25% or more of any voting securities
or to direct the management or policies of a bank holding company or an insured
bank.

         The Holding Company Act also prohibits, with certain exceptions, a bank
holding company from acquiring direct or indirect ownership or control of more
than 5% of the voting shares of a company that is not a bank or a bank holding
company, or from engaging directly or indirectly in activities other than those
of banking, managing or controlling banks, or providing services for its
subsidiaries. The principal exceptions to these prohibitions involve certain
non-bank activities which, by statute or by FRB regulation or order, have been
identified as activities closely related to the business of banking or managing
or controlling banks. The non-bank activities of the Holding Company are subject
to these legal and regulatory limitations under the Holding Company Act and the
FRB's regulations thereunder. Notwithstanding the FRB's prior approval of
specific nonbanking activities, the FRB has the power to order a holding company
or its subsidiaries to terminate any activity, or to terminate its ownership or
control of any subsidiary, when it has reasonable cause to believe that the
continuation of such activity or such ownership or control constitutes a serious
risk to the financial safety, soundness or stability of any bank subsidiary of
that holding company.

         The FRB has adopted guidelines regarding the capital adequacy of bank
holding companies, which require bank holding companies to maintain specified
minimum ratios of capital to total assets and capital to risk-weighted assets.
See "--Capital Requirements."

         The FRB has the power to prohibit dividends by bank holding companies
if their actions constitute unsafe or unsound practices. The FRB has issued a
policy statement on the payment of cash dividends by bank holding companies,
which expresses the FRB's view that a bank holding company should pay cash
dividends only to the extent that the company's net income for the past year is
sufficient to cover both the cash dividends and a rate of earning retention that
is consistent with the company's capital needs, asset quality, and overall
financial condition.

         Bank Regulation. As an Alabama banking institution, the Bank is subject
to regulation, supervision and regular examination by the Banking Department.
Furthermore, as a state bank that is not a member of the Federal Reserve System
(a "state nonmember bank"), the Bank is subject to regulation, supervision and
regular examination by the FDIC under the applicable provisions of the Federal
Deposit Insurance Act (the "FDI Act") and the FDIC's regulations. The deposits
of the Bank are insured by the FDIC to the maximum extent provided by law (a
maximum of $100,000 for each insured depositor). Alabama and federal banking
laws and regulations control, among other things, the Bank's required reserves,
investments, loans, mergers and consolidations, issuance of securities, payment
of dividends, and establishment of branches and other aspects of the Bank's
operations.



                                       17
<PAGE>   18

         The Bank is required to pay assessments, based on a percentage of its
insured deposits, to the FDIC for insurance of its deposits by the SAIF. The
FDIC has established a risk-based deposit insurance assessment system for
insured depository institutions, under which insured institutions are assigned
assessment risk classifications based upon capital levels and supervisory
evaluations.

         The FDIC has adopted a risk-based insurance assessment system for
determining the deposit insurance assessments to be paid by insured depository
institutions. The FDIC assigns an institution to one of three capital categories
based on the institution's financial information, as of the reporting period
ending seven months before the assessment period, consisting of (1) well
capitalized, (2) adequately capitalized or (3) undercapitalized, and one of
three supervisory subcategories within each capital group. The supervisory
subgroup to which an institution is assigned is based on a supervisory
evaluation provided to the FDIC by the institution's primary federal regulator
and information that the FDIC determines to be relevant to the institution's
financial condition and the risk posed to the deposit insurance funds.
Assessment rates for SAIF-member institutions like the Bank depend on the
capital category and supervisory category to which they are assigned and
currently range from $0 to 0.27% of insured deposits. In addition, SAIF-insured
institutions will be required, until December 31, 1999, to pay assessments to
the FDIC at the annual rate of approximately .066% of insured deposits to help
fund interest payments on certain bonds issued by the Financing Corporation
("FICO"), an agency of the federal government established to recapitalize the
predecessor to the SAIF. During this period, BIF member banks will be assessed
for payment of the FICO obligations at the annual rate of .013% of insured
deposits. After December 31, 1999, BIF and SAIF member institutions will be
assessed at the same rate for the FICO obligations.

         Under Alabama law, the approval of the Banking Department is required
if the total of all the dividends declared by the Bank in any calendar year
exceeds the Bank's net income as defined for that year combined with its
retained net income for the preceding two calendar years.

         The Bank is subject to various regulatory capital requirements
administered by the federal banking agencies, including the FDIC's capital
adequacy guidelines for state non-member banks. 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 Bank's and the Company's financial statements. See
"--Capital Requirements."

         The FDI Act requires the federal banking agencies, including the OTS,
to prescribe for all insured depository institutions standards relating to,
among other things, internal controls, information systems and audit systems,
loan documentation, credit underwriting, interest rate risk exposure, asset
growth, asset quality and compensation, fees and benefits and such other
operational and managerial standards as the agencies deem appropriate. The
federal banking agencies have adopted final regulations and Interagency
Guidelines Establishing Standards for Safety and Soundness ("Guidelines") to
implement safety and soundness standards pursuant to the statute. The Guidelines
set forth the safety and soundness standards that the federal banking agencies
use to identify and address problems at insured depository institutions before
capital becomes impaired. The Guidelines address internal controls and
information systems; internal audit system; credit underwriting; loan
documentation; interest rate risk exposure; asset growth; asset quality;
earnings; and compensation, fees and benefits. If the appropriate federal
banking agency determines that an institution fails to meet any standard
prescribed by the Guidelines, the agency may require the institution to submit
to the agency an acceptable plan to achieve compliance with the standard, as
required by the FDI Act.

         Supervision, regulation and examination of the Holding Company and the
Bank by the bank regulatory agencies are intended primarily for the protection
of depositors rather than for holders of Holding Company stock or of the Holding
Company as the holder of the stock of the Bank.

         Capital Requirements. The FRB has established guidelines with respect
to the maintenance of appropriate levels of capital by bank holding companies,
and the FDIC has promulgated substantially similar capital adequacy regulations
for state nonmember banks. These capital regulations impose two sets of capital
adequacy requirements: minimum leverage rules, which require bank holding
companies and banks to maintain a specified minimum ratio of capital to total
assets, and risk-based capital rules, which require the maintenance of specified
minimum ratios of capital to "risk-weighted" assets.



                                       18
<PAGE>   19

         The regulations of the FRB and the FDIC require bank holding companies
and state nonmember banks, respectively, to maintain a minimum leverage ratio of
"Tier 1 capital" (as defined in the risk-based capital guidelines discussed in
the following paragraphs) to total assets of 3.0%. Although setting a minimum
3.0% leverage ratio, the regulations state that only the strongest bank holding
companies and banks, with composite examination ratings of 1 under the rating
system used by the federal bank regulators, would be permitted to operate at or
near such minimum level of capital. All other bank holding companies and banks
are expected to maintain a leverage ratio of at least 1% to 2% above the minimum
ratio, depending on the assessment of an individual organization's capital
adequacy by its primary regulator. Any bank or bank holding company experiencing
or anticipating significant growth would be expected to maintain capital well
above the minimum levels. In addition, the FRB has indicated that whenever
appropriate, and in particular when a bank holding company is undertaking
expansion, seeking to engage in new activities or otherwise facing unusual or
abnormal risks, it will consider, on a case-by-case basis, the level of an
organization's ratio of tangible Tier 1 capital (after deducting all
intangibles) to total assets in making an overall assessment of capital.

         The risk-based capital rules of the FRB and the FDIC require bank
holding companies and state nonmember banks, respectively, to maintain minimum
regulatory capital levels based upon a weighing of their assets and off-balance
sheet obligations according to risk. The risk-based capital rules have two basic
components: a core capital (Tier 1) requirement and a supplementary capital
(Tier 2) requirement. Core capital consists primarily of common stockholders'
equity, certain perpetual preferred stock (which must be noncumulative with
respect to banks), and minority interests in the equity accounts of consolidated
subsidiaries; less intangible assets, primarily goodwill, with limited
exceptions for mortgage servicing rights and purchased credit card
relationships. Supplementary capital elements include, subject to certain
limitations, the allowance for losses on loans and leases; perpetual preferred
stock that does not qualify for Tier 1 and long-term preferred stock with an
original maturity of at least 20 years from issuance; hybrid capital
instruments, including perpetual debt and mandatory convertible securities; and
subordinated debt and intermediate-term preferred stock. The risk-based capital
regulations assign balance sheet assets and credit equivalent amounts of
off-balance sheet obligations to one of four broad risk categories based
principally on the degree of credit risk associated with the obligor. The assets
and off-balance sheet items in the four risk categories are weighted at 0%, 20%,
50% and 100%. These computations result in the total risk-weighted assets.

         The risk-based capital regulations require all banks and bank holding
companies to maintain a minimum ratio of total capital to total risk-weighted
assets of 8%, with at least 4% as core capital. For the purpose of calculating
these ratios: (i) supplementary capital will be limited to no more than 100% of
core capital; and (ii) the aggregate amount of certain types of supplementary
capital will be limited. In addition, the risk-based capital regulations limit
the allowance for loan losses includable as capital to 1.25% of total
risk-weighted assets.

         The FRB, the FDIC and the other banking agencies have amended the
risk-based capital standards to take account of a bank's concentration of credit
risk, the risk of nontraditional activities, and a bank's exposure to declines
in the economic value of its capital resulting from changes in interest rates.
The revised capital guidelines do not, however, codify a measurement framework
for assessing the level of a bank's interest rate exposure. The FRB, the FDIC
and the other banking agencies have adopted a joint policy statement requiring
that banks adopt comprehensive policies and procedures for managing interest
rate risk and setting forth general standards for such internal policies.



                                       19
<PAGE>   20

         The FDIC has issued final regulations that classify insured depository
institutions by capital levels and provide that the applicable agency will take
various prompt corrective actions to resolve the problems of any institution
that fails to satisfy the capital standards. Under such regulations, a
"well-capitalized" bank is one that is not subject to any regulatory order or
directive to meet any specific capital level and that has or exceeds the
following capital levels: a total risk-based capital ratio of 10%, a Tier 1
risk-based capital ratio of 6%, and a leverage ratio of 5%. An "adequately
capitalized" bank is one that does not qualify as "well capitalized" but meets
or exceeds the following capital requirements: a total risk-based capital of 8%,
a Tier 1 risk-based capital ratio of 4%, and a leverage ratio of either (i) 4%
or (ii) 3% if the bank has the highest composite examination rating. A bank not
meeting these criteria is treated as "undercapitalized," "significantly
undercapitalized," or "critically undercapitalized" depending on the extent to
which the bank's capital levels are below these standards. A bank that fails
within any of the three "undercapitalized" categories will be subject to certain
severe regulatory sanctions under the FDIC prompt corrective action regulation.
As of December 31, 1997, the Bank was categorized as "well-capitalized" by the
FDIC.

         See Item 6, "Management's Discussion and Analysis or Plan of
Operation," and Note __ of Notes to Consolidated Financial Statements contained
in the Holding Company's Annual Report to Stockholders for the year ended
December 31, 1997 (Exhibit No. 13) which is incorporated herein by reference.

         Effects of Governmental Policy. The earnings and business of the
Holding Company and the Bank have been and will be affected by the policies of
various regulatory authorities of the United States, particularly the FRB.
Important functions of the FRB, in addition to those enumerated above, include
the regulation of the supply of money in light of general economic conditions
within the United States. The instruments of monetary policy employed by the FRB
for these purposes influence in various ways the overall level of investments,
loans, other extensions of credit and deposits, and the interest rates paid on
liabilities and received on interest-earning assets.

         Banking is a business which depends on interest rate differentials. In
general, the difference between the interest paid by the Bank on its deposits
and its other borrowings and the interest received by the Bank on loans extended
to customers and securities held in its investment portfolios comprises the
major portion of the Bank's earnings. The earnings and gross income of the Bank
thus have been and will be subject to the influence of economic conditions
generally, both domestic and foreign, and also to monetary and fiscal policies
of the United States and its agencies, particularly the FRB. The nature and
timing of any future changes in such policies and their impact on the Bank are
not predictable. 

EMPLOYEES

         As of December 31, 1998, the Holding Company and the Bank had 85
full-time and 22 part-time employees.

         The employees are not represented by a collective bargaining agreement.
The Holding Company and the Bank believe their employee relations are good.

EXECUTIVE OFFICERS OF THE REGISTRANT

<TABLE>
<CAPTION>
Name, Age and Position                                    Business Experience
----------------------                                    -------------------

<S>                                                       <C> 
Robert B. Nolen, Jr., 40 -                                Mr. Nolen joined the Bank in 1987 as First Vice
   President of the Holding                               President, Chief Financial Officer and Treasurer.  
   Company and the Bank                                   Effective July 1, 1994, Mr. Nolen was appointed
                                                          President and Chief Executive Officer of the Bank.
                                                          As President of each of the Holding Company and Bank,
                                                          Mr. Nolen is responsible for ensuring that the
                                                          overall operations of the Holding Company and the
                                                          Bank are carried out in accordance with the
                                                          policies and procedures of the Board of Directors. 
</TABLE>



                                       20
<PAGE>   21

<TABLE>
<S>                                                       <C>  
Mary Jo Gunter, 46 -                                      Ms. Gunter joined the Bank in September 1976 and
   Vice President of the                                  has served in various lending related positions within
   Holding Company and Senior                             the Bank. She is responsible for branch operations,
   Vice President - Banking Services                      personnel, loan servicing and other customer service
   of the Bank.                                           areas.
</TABLE>

FORWARD-LOOKING STATEMENTS

         This Annual Report on Form 10-KSB, including all documents incorporated
herein by reference, contains forward-looking statements. Additional written or
oral forward-looking statements may be made by the Holding Company from time to
time in filings with the Securities and Exchange Commission or otherwise. The
words "believe," "expect," "seek," and "intend" and similar expressions identify
forward-looking statements, which speak only as of the date the statement is
made. Such forward-looking statements are within the meaning of that term in
Section 27A of the Securities Act of 1933, as amended, and Section 21E of the
Securities Exchange Act of 1934, as amended. Such statements may include, but
are not limited to, projections of income or loss, expenditures, acquisitions,
plans for future operations, financing needs or plans relating to services of
the Holding Company, as assumptions relating to the foregoing. Forward-looking
statements are inherently subject to risks and uncertainties, some of which
cannot be predicted or quantified. Future events and actual results could differ
materially from those set forth in, contemplated by or underlying the
forward-looking statements.

         The Holding Company does not undertake, and specifically disclaims, any
obligation to publicly release the results of revisions which may be made to
forward-looking statements to reflect the occurrence of anticipated or
unanticipated events or circumstances after the date of such statements.

ITEM 2.  DESCRIPTION OF PROPERTY

         The Holding Company's principal executive offices and the Bank's main
office are located at 1811 Second Avenue, Jasper, Alabama. At December 31, 1998,
the Bank maintained six branches in Jasper, Haleyville, Sumiton, Vestavia and
Trussville, Alabama. The Haleyville branch is leased. The Bank also leases an
administrative office in Jasper, Alabama, which is currently subleased to
another financial institution.

         For further information on the Bank's lease commitments, see Note 4 of
Notes to Consolidated Financial Statements.

         The total net book value of the Bank's investment in premises and
equipment was $6,600,000 at December 31, 1998. See Note 4 of Notes to
Consolidated Financial Statements for further information.

ITEM 3.  LEGAL PROCEEDINGS

         On October 27, 1993, a suit was initiated in the Circuit Court for
Walker County, Alabama by one customer who alleged that the Bank improperly
charged his account for insufficient funds. The plaintiff also alleged that he
represented a class composed of both current and past customers of the Bank. The
Bank denied the material allegations of the plaintiff's complaint. Despite the
fact that no discovery had been taken, the Court set the matter for preliminary
injunction, summary judgment, class action certification and other matters on
January 25, 1994. Notwithstanding, on January 28, 1994, the Court ordered that
the suit proceed as a class action but did not rule on the validity and
truthfulness of the allegations in the complaint. The Bank filed a motion for
the Circuit Court Judge to recuse himself, which was refused. Additionally, on
motion of the plaintiff's attorney, the Judge disqualified the Bank's attorneys
from further representation of the Bank in this litigation. The Circuit Court
then entered a Scheduling Order resulting in a trial setting in September 1994.
The Bank appealed the rulings of the Circuit Court to the Alabama Supreme Court.
The Alabama Supreme Court subsequently stayed all orders of the Circuit Court
pending its review of all matters before it. No date has been set for a ruling
by the Supreme Court on the Bank's pending motions. There has been no
substantive change in the status of this lawsuit.



                                       21
<PAGE>   22

         Three suits are currently pending against the Bank in the Circuit Court
for Walker County, Alabama which involve the sale of credit life insurance -
Rhonda Hood vs. First Federal of Alabama, Patricia Green vs. First Federal of
Alabama, and Dutton vs. First Federal of Alabama. The oldest of these cases,
Dutton, was initiated in 1994 and has never been considered by the Bank to be
material to its business or financial condition. The most recent cases, Hood and
Green, were initiated on January 18, 1996 and January 23, 1996, respectively,
and allege overcharging for credit life insurance, as well as misrepresentations
regarding splitting of the commission or premium between the Bank and the
insurance company with which it dealt. In the event a settlement is not effected
in the Hood and Green cases, the Bank anticipates that each of the plaintiffs
therein will allege that the plaintiff represents a class composed of customers
of the Bank. No amount of compensatory or punitive damages has been claimed in
the Hood and Green cases.

         Another suit against the Bank in the Circuit Court for Walker County,
Alabama alleged that the Bank wrongfully took possession of a foreclosure
property prior to foreclosure and converted such property to its use - White v.
First Federal of Alabama. The plaintiff sought both compensatory and punitive
damages. This case was settled for $5,000.

         In addition to the litigation noted above, the Bank is from time to
time subject to routine litigation incidental to its business. Such litigation
may include alleged compensatory and punitive damages. In recent years in the
State of Alabama many complaints have been filed which ultimately seek punitive
damage awards in amounts that bear little or no relation to actual damages. In
some of these cases, juries have awarded large punitive damage awards to the
plaintiffs.

         Although it is not possible to determine with any certainty at this
point in time the potential exposures related to damages in connection with any
pending litigation against the Bank, it is the opinion of management, based upon
consultation with legal counsel, that the ultimate resolution of all pending
litigation against the Bank will not have a materially adverse effect on the
Bank's business or financial condition.

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

         No matters were submitted during the fourth quarter of the fiscal year
covered by this report to a vote of security holders of the Holding Company
through a solicitation of proxies or otherwise.


                                     PART II

ITEM 5.  MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

         The information contained under the section captioned "Market Price and
Dividend Information" in the Holding Company's Annual Report to Stockholders for
the year ended December 31, 1998 (Exhibit No. 13), is incorporated herein by
reference.

ITEM 6.  MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION

         The information contained in the section captioned "Management's
Discussion and Analysis" in the Annual Report to Stockholders for the year ended
December 31, 1998 (Exhibit No. 13) is incorporated herein by reference.

ITEM 7.  FINANCIAL STATEMENTS

         The financial statements contained in the Annual Report to Stockholders
for the year ended December 31, 1998 (Exhibit No. 13) are incorporated herein by
reference.

ITEM 8.  CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE

         Not applicable.



                                       22
<PAGE>   23

                                    PART III

ITEM 9.  DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS; 
COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT

         For information concerning the Board of Directors of the Holding
Company, the information contained under the section captioned "Proposal I --
Election of Directors" in the Holding Company's definitive proxy statement, to
be filed within 120 days after the end of the fiscal year covered by this Form
10-KSB (the "Proxy Statement"), is incorporated herein by reference. For
information concerning the executive officers of the Holding Company, see "Item
1. Business -- Executive Officers of the Registrant," which is incorporated
herein by reference.

ITEM 10. EXECUTIVE COMPENSATION

         The information contained under the section captioned "Proposal I --
Election of Directors -- Executive Compensation" in the Proxy Statement is
incorporated herein by reference.

ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

         (a)    Security Ownership of Certain Beneficial Owners

                Information required by this item is incorporated herein by
                reference to the section captioned "Voting Securities and
                Principal Holders Thereof" of the Proxy Statement.

         (b)    Security Ownership of Management

                Information required by this item is incorporated herein by
                reference to the sections captioned "Voting Securities and
                Principal Holders Thereof" and "Proposal I -- Election of
                Directors" of the Proxy Statement.

         (c)    Changes in Control

                Management of the Registrant knows of no arrangements, including
                any pledge by any person of securities of the Registrant, the
                operation of which may at a subsequent date result in a change
                of control of the Registrant.

ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

         The information required by this item is incorporated herein by
reference to the sections captioned "Proposal I -- Election of Directors" and
"Voting Securities and Principal Holders Thereof" of the Proxy Statement.

ITEM 13. EXHIBITS, LIST AND REPORTS ON FORM 8-K

         (a)      Exhibits

                  3.1      Certificate of Incorporation - Incorporated by
                           reference to Exhibit 3.1 to Registrant's Annual
                           Report on Form 10-KSB for the six months ended
                           December 31, 1996.

                  3.2      Bylaws - Incorporated by reference to Exhibit 3.2 to
                           Registrant's Annual Report on Form 10-KSB for the six
                           months ended December 31, 1996.

                  4        Form of Stock Certificate - Incorporated by reference
                           to Exhibit 4 to Registrant's Annual Report on Form
                           10-KSB for the six months ended December 31, 1996.



                                       23
<PAGE>   24

                  10.1     Employment Agreement between the Registrant and
                           Robert B. Nolen, Jr. - Incorporated by reference to
                           Exhibit 10.2 to the Registrant's Registration
                           Statement on Form S-4 (File No. 333-11495)

                  10.2     Pinnacle Bank 1996 Stock Option and Incentive Plan -
                           Incorporated by reference to Exhibit 10.4 to the
                           Registrant's Registration Statement on Form S-4 (File
                           No. 333-11495)

                  13       Annual Report to Stockholders for the year ended
                           December 31, 1998. Except for the portions of the
                           Annual Report to Stockholders which are expressly
                           incorporated herein by reference, such Annual Report
                           to Stockholders is furnished for the information of
                           the SEC and is not to be deemed "filed" as part of
                           this Report.

                  21       Subsidiaries

                  23       Consent of Independent Accountants

                  27       Financial Data Schedule (SEC use only)

         (b)      Not applicable.



                                       24
<PAGE>   25

                                   SIGNATURES

         In accordance with Section 13 or 15(d) of the Exchange Act, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.

                                            PINNACLE BANCSHARES, INC.


Date:  April 13, 1999                       By: /s/ Robert B. Nolen, Jr.
                                                --------------------------------
                                                Robert B. Nolen, Jr., President
                                                (Duly Authorized Representative)

       In accordance with the Exchange Act, this report has been signed below by
the following persons on behalf of the registrant and in the capacities and on
the dates indicated.

<TABLE>
<S>                                                           <C> 
By:    /s/ Robert B. Nolen, Jr.                               By:    /s/ James W. Cannon                 
       -------------------------------------                         -------------------------------------
       Robert B. Nolen, Jr.                                          James W. Cannon
       President and Chief Executive Officer                         Director
       (Principal Executive Officer, Principal
       Financial Officer and Principal Accounting
       Officer)

Date:  April 13, 1999                                         Date:  April 13, 1999

By:    /s/ Albert H. Simmons                                  By:  
       -------------------------------------                         -------------------------------------
       Albert H. Simmons                                             Max W. Perdue
       Chairman of the Board                                         Director

Date:  April 13, 1999                                         Date:  April __, 1999

By:    /s/ O. H. Brown                                        By:    /s/ Greg Batchelor 
       -------------------------------------                         -------------------------------------
       O. H. Brown                                                   Greg Batchelor
       Director                                                      Director

Date:  April 13, 1999                                         Date:  April 13, 1999

By:                                                           By:    /s/ Melvin R. Kacharos
       -------------------------------------                         -------------------------------------
       Sam W. Murphy                                                 Melvin R. Kacharos
       Director                                                      Director

Date:  April __, 1999                                         Date:  April 13, 1999

By:    /s/ J. T. Waggoner
       -------------------------------------                      
       J. T. Waggoner
       Director

Date:  April 13, 1999
</TABLE>