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

                                  FORM 10-KSB

[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

                        Commission File Number:  0-25478

 
                        FIRST SOUTHERN BANCSHARES, INC.
-------------------------------------------------------------------------------
       (Exact name of small business issuer as specified in its charter)
<TABLE>
<CAPTION>
 
<S>                                                              <C>
                  Delaware                                                   63-1133624
---------------------------------------------                    -----------------------------------
      (State or other jurisdiction of                            (I.R.S. Employer Identification No.)
       incorporation or organization)
 
 
 
102 South Court Street, Florence, Alabama                                       35630
-----------------------------------------                        -----------------------------------
(Address of principal executive offices)                                     (Zip Code)
 
 
 
Registrant's telephone number, including area code                          (256) 764-7131
 
 
 
Securities registered pursuant to Section 12(b) of the Act:                      None
 
 
 
Securities registered pursuant to Section 12(g) of the Act:      Common Stock, par value $0.01 per share
                                                                 ---------------------------------------
                                                                           (Title of Class)
</TABLE>

Check whether the issuer (1) has filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding
12 months (or for such shorter period that the registrant was required to file
such reports), and (2) has been subject to such filing requirements for the past
90 days. YES  X  NO 
             ---    ---   

Check if there is no disclosure of delinquent filers pursuant to Item 405 of
Regulation SB contained herein, and no disclosure will be contained, to the best
of the issuer's knowledge, in definitive proxy or other information statements
incorporated by reference in Part III of this Form 10-KSB or any amendments to
this Form 10-KSB.  X
                  ---

The aggregate market value of the outstanding voting stock held by nonaffiliates
of the Registrant, based on the closing sales price of the registrant's Common
Stock as quoted on The Nasdaq National Market under the symbol "FSTH" on March
19, 1999, was $15,390,698 (1,194,930 shares at $12.88 per share).  It is assumed
for purposes of this calculation that the issuer's executive officers, directors
and 5% stockholders are affiliates.

The issuer's revenues for the fiscal year ended December 31, 1998 were
$16,133,000.

                      DOCUMENTS INCORPORATED BY REFERENCE

1.   Portions of Annual Report to Stockholders for the Fiscal Year Ended
     December 31, 1998 ("Annual Report"). (Parts I and II)
2.   Portions of Proxy Statement for the Annual Meeting of Stockholders ("Proxy
     Statement"). (Parts III and IV)

Transitional Small Business Disclosure Format  Yes       No  X
                                                  -----    -----
<PAGE>
 
     This report contains certain "forward-looking statements" concerning the
future operations of First Southern Bancshares, Inc. and its wholly-owned
subsidiary, First Southern Bank  Forward-looking statements are used to describe
future plans and strategies, including expectations of future financial results.
Management's ability to predict results or the effect of future plans or
strategies is inherently uncertain.  Factors which could affect actual results
include interest rate trends, the general economic climate in the market area in
which First Southern Bancshares, Inc. and First Southern Bank operate, as well
as nationwide, First Southern Bancshares, Inc.'s and First Southern Bank's
abilities to control costs and expenses, competitive products and pricing, loan
delinquency rates, changes in federal and state legislation and regulation, and
the impact of Year 2000 issues.  These factors should be considered in
evaluating the forward-looking statements and undue reliance should not be
placed on such statements.

                                    PART I

Item 1.  Description of Business
--------------------------------

General

          First Southern Bancshares, Inc. ("Company"), a Delaware corporation,
was organized on November 22, 1994 for the purpose of becoming the holding
company for First Federal Savings and Loan Association of Florence
("Association") upon the Association's conversion from a federally chartered
mutual savings and loan association to a federally chartered capital stock
savings and loan association ("Stock Conversion") and then to an Alabama
chartered commercial bank ("Bank Conversion").  The Stock Conversion was
consummated on April 13, 1995 through the issuance and sale by the Company of
2,049,875 shares of common stock, $0.01 par value, at $10.00 per share to
depositors of the Association and the Association's employee stock ownership
plan.  The Bank Conversion was consummated on June 10, 1995, with the
Association changing its name to "First Southern Bank" ("Bank").  At December
31, 1998, the Company had total assets of $178.4 million, total deposits of
$127.6 million and stockholders' equity of $18.0 million.  The Company has not
engaged in any significant activity other than holding all of the outstanding
capital stock of the Bank.  Accordingly, the information set forth in this
report, including financial statements and related data, relates primarily to
the Bank.

          The Company is a registered bank holding company regulated by the
Federal Reserve Board ("FRB").  The Bank's primary regulator is the
Superintendent of Banks of the State of Alabama ("Superintendent").  The Bank's
deposits are insured up to applicable limits under the Savings Association
Insurance Fund ("SAIF") of the Federal Deposit Insurance Company ("FDIC").  The
Bank is a member of the Federal Home Loan Bank ("FHLB") System.  The executive
offices of the Company and the Bank are located at 102 South Court Street,
Florence, Alabama 35630 and their telephone number is (256) 764-7131.

          The Bank conducts its business through six office facilities located
in Lauderdale and Colbert Counties in northwestern Alabama, which the Bank
considers as its primary market area.  See "-- Properties."  The two largest
industries in this area are Reynolds Aluminum Co. and the Tennessee Valley
Authority.  The University of North Alabama and the Eliza Coffee Memorial
Hospital are located in Florence, Alabama, and both have a significant economic
impact on the Bank's primary market area.  The textile industry has become an
increasingly significant segment of the local economy, with many small textile
businesses located in the Bank's primary market area.  The Bank faces strong
competition for the attraction of savings deposits and the origination of loans
in its primary market area.  See "-- Competition."

Selected Financial Condition, Operating and Other Data and Key Operating Ratios

               This information is incorporated by reference to pages 3 and 4 of
the Annual Report.

                                       1
<PAGE>
 
Average Balance Sheets

      This information is incorporated by reference to page 5 of the Annual
      Report.

Rate/Volume Analysis

      This information is incorporated by reference to page 6 of the Annual
      Report.

Interest Rate Sensitivity Analysis

      This information is incorporated by reference to page 7 of the Annual
      Report.

Lending Activities

          General.  The Bank's primary lending activity is the origination of
mortgage loans for the purchase and re-finance of one- to four-family owner-
occupied residences.  The Bank also actively originates commercial loans,
construction loans, consumer loans, and multi-family residential real estate
loans, principally in the Bank's primary market area, as part of its commercial
banking strategy.  These other types of lending are generally considered to
involve greater credit risks than one- to four-family mortgage lending.  See "--
Lending Activities -- Multi-Family Loans," "--Commercial Real Estate and
Commercial Business Loans."

                                       2
<PAGE>
 
          Loan Portfolio Analysis.  The following table sets forth the
composition of the Bank's loan portfolio as of the dates indicated.
<TABLE>
<CAPTION>
 
                                                                  At December 31,
                                        ----------------------------------------------------------------
                                                1996                  1997                   1998
                                        -------------------  --------------------   --------------------
                                          Amount    Percent    Amount     Percent     Amount    Percent
                                        ---------  --------  ---------  ---------   ---------  ---------
                                                                (Dollars in thousands)
<S>                                      <C>       <C>       <C>         <C>        <C>        <C>  
Mortgage loans:
   One- to four-family residential(1)..  $ 66,863    41.86%  $ 58,339      36.52%    $ 53,019     34.60%
   Multi-family residential............    13,045     8.17     11,020       6.90        6,473      4.22
   Commercial..........................    33,434    20.93     37,535      23.49       33,516     21.87
                                         --------   ------    -------     ------      -------    ------ 
      Total non-construction                        
         mortgage loans................   113,342    70.96    106,894      66.91       93,008     60.69  
                                         --------   ------    -------     ------      -------    ------  
                                                    
Construction loans:                                 
   One- to four-family residential.....     4,970     3.12      6,624       4.14       10,032      6.54
   Multi-family residential............       327     0.20         --         --           --        --
   Commercial..........................        --       --      1,606       1.01        2,050      1.34
                                         --------   ------    -------     ------      -------    ------   
      Total construction loans.........     5,297     3.32      8,230       5.15       12,082      7.88
                                         --------   ------    -------     ------      -------    ------     
Total mortgage loans...................   118,639    74.28    115,124      72.06      105,090     68.57
                                         --------   ------    -------     ------      -------    ------  
Commercial business loans..............    27,157    17.00     27,792      17.40       29,010     18.93
                                         --------   ------    -------     ------      -------    ------  
                                                    
Consumer loans:                                     
   Home equity and second                           
      mortgage loans...................     9,023     5.65      9,999       6.26       10,140      6.62 
   Automobile loans....................     2,455     1.54      3,152       1.97        3,953      2.58
   Savings loans.......................       599     0.38        739       0.46          886      0.58
                                                    
   Other...............................     5,624     3.52      6,088       3.81        6,787      4.43
                                         --------   ------    -------     ------      -------    ------ 
      Total consumer loans.............    17,701    11.09     19,978      12.50       21,766     14.21
                                         --------   ------    -------     ------      -------    ------  
Total loans............................   163,497   102.37    162,894     101.96      155,866    101.71
                                         --------   ------    -------     ------      -------    ------  
                                                    
Less:                                               
   Undisbursed loans in process........     1,928     1.21      1,404       0.88        1,103      0.72
   Unamortized loan origination                                                               
      fees, net of direct costs........       192     0.12        148       0.09           69      0.05    
   Allowance for possible                           
      loan losses......................     1,659     1.04      1,584       0.99        1,441      0.94
                                         --------   ------   --------     ------     --------    ------    
      Net loans receivable.............  $159,718   100.00%  $159,758     100.00%    $153,253    100.00%
                                         ========   ======   ========     ======     ========    ======
--------------------------------------
</TABLE>
(1)  Includes loans held for sale.

          One- to Four-Family Residential Loans.  At December 31, 1998, $53.0
million, or 34.6% of the Bank's net loans receivable (including loans held for
sale) consisted of loans secured by one- to four-family residential real estate.
A substantial portion of this amount consisted of adjustable rate one- to four-
family mortgage ("ARM") loans.

          The Bank presently originates both fixed-rate mortgage loans and ARM
loans secured by single-family properties with terms of 15 to 30 years, with an
emphasis on ARM loans.  Borrower demand for ARM loans versus

                                       3
<PAGE>
 
fixed-rate mortgage loans is a function of the level of interest rates, the
expectations of changes in the level of interest rates and the difference
between the initial interest rates and fees charged for each type of loan.  The
relative amount of fixed-rate mortgage loans and ARM loans that can be
originated at any time is largely determined by the demand for each in a
competitive environment.

          The Bank currently offers ARM loans with initial rates determined by
the Bank based on market factors and competitive rates for loans having similar
features offered by other lenders for such initial periods.  The Bank originates
ARM loans that adjust annually with a maximum upward adjustment of 2% per year
and a 6% maximum adjustment over the life of the loan.  Many of the ARM loans
have interest rate adjustment floors that do not permit the rate to be adjusted
below a certain rate.  ARM loans are tied either to the one-year U.S. Treasury
Bill Index or the Cost of Funds Index.  At December 31, 1998, the initial
interest rate on the Bank's ARM loans was 6.00% per annum.   The Bank does not
originate negative amortization loans.  The Bank originated $8.8 million of one-
to four-family ARM loans for the year ended December 31, 1998.

          The Bank underwrites ARM loans based on the borrower's ability to
repay the loan assuming a rate of 2.0% higher than the initial rate on the ARM
loans and that such rate will remain constant during the loan term.  As a
result, the potential for a substantial increase in interest payments on ARMs
decreases the likelihood of delinquencies and defaults.

          While single-family residential real estate loans are normally
originated with 15- and 30-year terms and the Bank permits its ARM loans to be
assumed by qualified borrowers, such loans typically remain outstanding for
substantially shorter periods.  This is because borrowers often prepay their
loans in full upon sale of the property pledged as security or upon refinancing
the original loan.  In addition, substantially all mortgage loans in the Bank's
loan portfolio contain due-on-sale clauses providing that the Bank may declare
the unpaid amount due and payable upon the sale of the property securing the
loan.  The Bank enforces these due-on-sale clauses to the extent permitted by
law and as business judgment dictates.  Thus, average loan maturity is a
function of, among other factors, the level of purchase and sale activity in the
real estate market, prevailing interest rates and the interest rates payable on
outstanding loans.

          The retention of ARM loans in the Bank's loan portfolio helps reduce
the Bank's exposure to changes in the interest rates.  There are, however,
unquantifiable credit risks resulting from the potential of increased costs due
to changed rates to be paid by the customer.  It is possible that, during
periods of rising interest rates, the risk of default on ARM loans may increase
as a result of repricing and the increased costs to the borrower.  Furthermore,
the ARM loans originated by the Bank generally provide, as a marketing
incentive, for initial rates of interest below the rates which would apply were
the adjustment index used for pricing initially (discounting).  These loans are
subject to increased risks of default or delinquency because of this.  Another
consideration is that although ARM loans allow the Bank to increase the
sensitivity of its asset base to changes in the interest rates, the extent of
this interest sensitivity is limited by the periodic and lifetime interest rate
adjustment limits.  Because of these considerations, the Bank has no assurance
that yields on ARM loans will be sufficient to offset increases in the Bank's
cost of funds.

          The Bank also originates conventional fixed-rate mortgage loans on
one- to four-family residential  properties and is a direct endorsed lender for
Federal Home Administration ("FHA") and Veterans Administration ("VA") loans.
All FHA and VA loans are currently originated through the Muscle Shoals branch
office.  The Bank originated $29.4 million of fixed-rate one-to four-family
mortgage loans for the year ended December 31, 1998.  Substantially all FHA and
VA loans were originated for sale.  See "-- Loan Originations, Sales and
Purchases."

          The Bank requires title insurance insuring the status of its lien on
all of the real estate secured loans and also requires that the fire and
extended coverage casualty insurance (and, if appropriate, flood insurance) be
maintained in an amount at least equal to the outstanding loan balance.

          The Bank's lending policies generally limit the maximum loan-to-value
ratio on mortgage loans secured by owner-occupied properties to 80% of the
lesser of the appraisal value or the purchase price, with the condition that
private mortgage insurance is required on loans with loan-to-value ratios of
greater than 80%.  The maximum loan-to-value 

                                       4
<PAGE>
 
ratio for construction-permanent loans is also 80% of the appraised value or
cost, whichever is less. The Bank requires private mortgage insurance for loan-
to-value ratios in excess of 80%.

          The maximum financing on refinance loans is limited to 80% of the
appraised value and such loans require private mortgage insurance above 80%
loan-to-value, or 80% loan to appraised value if a portion of the funds advanced
by the Bank will be used for purposes other than paying off the existing
mortgage debt.

          Multi-Family Loans.  At December 31, 1998, $6.5 million, or 4.2% of
the Bank's net loans receivable consisted of loans secured by multi-family
properties.  Multi-family loans are comprised primarily of loans secured by
income producing properties such as apartments with five to 50 units.  Multi-
family real estate loans are generally made in amounts between $300,000 and
$700,000, are originated at 80% of the appraised value of the property or
selling price, whichever, is less, and are generally originated for ten- to 25-
year terms.

          Multi-family lending is generally viewed as exposing the lender to a
greater risk of loss than one- to four-family residential lending.  Such loans
typically involve higher loan principal amounts and loan repayment is largely
dependent on sufficient income generated by the project to cover operating
expenses and loan repayments.  Market values may vary as a result of economic
events or governmental regulations outside of the control of the borrower or
lender, such as rent control laws, which impact the future cash flows of the
affected properties.  Corresponding to the greater lending risk is a generally
higher interest rate applicable to multi-family lending.  The Bank generally
requires that the security property generate positive cash flow after debt
service and other expenses.  The Bank's underwriting criteria includes an
evaluation of the borrower's reputation, the amount of borrower's equity in the
project, sales and leasing information, and cash flow projections.  At 
December 31, 1998, the Bank had no nonperforming (i.e. loans accounted for on a
nonaccrual basis and accruing loans contractually past due 90 days or more)
multi-family residential loans.

          At December 31, 1998, the three largest multi-family loans were a 
$1.4 million loan secured by an apartment building in Muscle Shoals, Alabama, 
a $1.2 million loan secured by an apartment building complex in Sheffield,
Alabama, and a $1.0 million loan secured by an apartment building in Tampa,
Florida. All three loans were current at December 31, 1998.

          Construction Loans.  At December 31, 1998, the Bank had $12.1 million
of construction loans, or 7.9% of net loans receivable.  The Bank originates
residential construction mortgage loans to residential owner-occupants (custom
construction loans) and to local contractors building residential properties for
resale, as well as construction loans for multi-family residential properties
and land development on properties located within its primary market area.
Construction loans to owner-occupants generally have a term of six months and
then are converted to permanent loans.  The construction loans to builders
generally are in amounts below $200,000 and are made with a six-month term.  The
Bank's construction loans bear interest rates which adjust with the U.S.
Treasury Index.  Approximately $6.5 million, or 16.5%, and $8.3 million, or
15.9% of the mortgage loans originated by the Bank for the years ended December
31, 1996 and 1997, respectively, were construction loans as compared to 
$10.8 million, or 16.8% for the year ended December 31, 1998.

          Construction lending is generally considered to involve a higher
degree of credit risk than long-term financing of residential properties.  The
risk of loss on a construction loan is dependent largely upon the accuracy of
the initial estimate of the property's value at completion of construction or
development and the estimated cost (including interest) of construction.  If the
estimate of construction cost and the marketability of the property upon
completion of the project prove to be inaccurate, the Bank may be compelled to
advance additional funds to complete the development.  If the borrower is unable
to sell the completed project in a timely manner or obtain adequate proceeds to
repay the loan, the loan may become nonperforming.  Furthermore, if the estimate
of value proves to be inaccurate, the Bank may be confronted with, at or prior
to the maturity of the loan, a project with a value which is insufficient to
assure full repayment.  The ability of the developer or builder to sell
developed lots or completed dwelling units will depend on, among other things,
demand, pricing and availability of comparable properties, and economic
conditions.

                                       5
<PAGE>
 
          The Bank's underwriting criteria are designed to evaluate and minimize
the risks of each construction loan.  Among other things, the Bank considers
evidence of the availability of permanent financing for the borrower, the
reputation of the borrower, the amount of the borrower's equity in the project,
the independent appraisal and review of cost estimates, the pre-construction
sale and leasing information, and the cash flow projections of the borrower.  In
addition, most of the construction loans granted by the Bank are secured by
property in the Bank's local market area.

          At December 31, 1998, the Bank had three construction loans with
committed balances of more than $1.0 million, all of which were current at that
date.  The first is a 34% participation interest in a $5.0 loan commitment
secured by land and a shopping center in Killen, Alabama.  The Bank's interest
amounts to $1.8 million.  At December 31, 1998, there was $120,000 outstanding
under the commitment, in which the Bank had a 34% interest.  The second is a
$1.2 million loan secured by an apartment building located in Greensboro,
Alabama, with an outstanding balance of $399,000 at December 31, 1998.  The
third is a $1.2 million loan secured by a residential sub-division development
located in Tuscumbia, Alabama, with an outstanding balance of $973,000 at
December 31, 1998.

          Consumer Loans.  Consumer loans generally have shorter terms to
maturity or repricing and higher interest rates than the long-term, fixed-rate
mortgage loans.  The Bank's consumer loans consist of loans secured by
automobiles, boats and recreational vehicles, mortgages on residences and
savings accounts, and unsecured loans for any personal or household purposes.
At December 31, 1998, consumer loans totaled $21.8 million, or 14.2% of net
loans receivable.  The Bank has not actively marketed its consumer loans and the
majority of such loans originated by the Bank have been made to its existing
customers.  The Bank, however, subject to market conditions, intends to actively
market consumer loans beyond its existing customer base to prospective borrowers
within its primary market area.

          The Bank offers closed-end, fixed-rate home equity and second mortgage
loans that are made on the security of residences.  Loans normally do not exceed
89% of the appraised value of the residence, less the outstanding principal of
the first mortgage and have terms of up to 15 years requiring monthly payments
of principal and interest.  At December 31, 1998, total outstanding home equity
and second mortgage loans amounted to $10.1 million, or 6.6% of net loans
receivable.

          The Bank offers automobile loans on both new and used vehicles.
Automobile loans are generally made at fixed interest rates, with terms up to 60
months and loan-to-value ratios up to 90%.

          The Bank makes savings account loans for up to 97% of the depositor's
savings account balance.  The interest rate is normally 2% above the rate paid
on the savings account, and the account must be pledged as collateral to secure
the loan.  Savings account loans are payable in monthly payments of principal
and interest or in a single payment.  At December 31, 1998, total loans on
savings accounts amounted to $886,000, or 0.6% of net loans receivable.

          Consumer loans entail greater risk than do residential mortgage loans,
particularly in the case of consumer loans which are unsecured or secured by
rapidly depreciating assets such as automobiles.  In such cases, any repossessed
collateral for a defaulted consumer loan may not provide an adequate source of
repayment of the outstanding loan balance as a result of the greater likelihood
of damage, loss or depreciation.  The remaining deficiency often does not
warrant further substantial collection efforts against the borrower beyond
obtaining a deficiency judgment.  In addition, consumer loan collections are
dependent on the borrower's continuing financial stability, and thus are more
likely to be adversely affected by job loss, divorce, illness or personal
bankruptcy.  Furthermore, the application of various federal and state laws,
including federal and state bankruptcy and insolvency laws, may limit the amount
which can be recovered on such loans.  Such loans may also give rise to claims
and defenses by a consumer loan borrower against an assignee of such loans such
as the Bank, and a borrower may be able to assert against such assignee claims
and defenses that it has against the seller of the underlying collateral.  At
December 31, 1998, $105,000, or 0.5% of the Bank's consumer loan portfolio was
accounted for on a nonaccrual basis or was contractually past due 90 days or
more.

          Commercial Real Estate Loans.  The Bank originates loans secured by
commercial real estate located primarily within the Bank's market area, and to a
lesser extent outside of Alabama.  Commercial real 

                                       6
<PAGE>
 
estate loans are generally secured by small commercial properties such as
doctor's offices and strip shopping centers. Commercial real estate loans are
written for terms of five, ten or 20 years with interest rates tied to the
comparable U.S. Treasury Constant Maturity Index or prime rates. Since the size
of commercial real estate loans creates greater potential for loss, the Bank
attempts to apply conservative underwriting standards to this type of lending.
The Bank primarily limits such lending to properties located in its primary
market area and to borrower's who are well known to the Bank. The Bank generally
requires annual financial statements from its commercial real estate borrowers
and personal guarantees if the borrower is a corporation. Commercial real estate
lending generally involves greater risk than residential mortgage lending. The
risks associated with the commercial real estate lending as similar to those
associated with multi-family real estate lending. See "-- Multi-Family Loans."

          At December 31, 1998, loans secured by commercial real estate totaled
$33.5 million, or 21.9% of net loans receivable.  A substantial portion of such
commercial real estate loans are secured by properties located in the Bank's
primary market area.

          At December 31, 1998, the three largest commercial real estate loans
were a $1.7 million loan secured by restaurants in Florence and Decatur,
Alabama, a $2.2 million loan secured by a country club and golf course located
in Muscle Shoals, Alabama, and a $1.4 million loan secured by five furniture
stores in Northern Alabama.  All three loans were current at December 31, 1998.

          At December 31, 1998, nonperforming (i.e. loans accounted for on a
nonaccrual basis and accruing loans contractually past due 90 days or more)
commercial real estate loans totaled $243,000.  See " -- Nonperforming Assets
and Delinquencies."

          Commercial Business Loans.  At December 31, 1998, the commercial
business loan portfolio totaled approximately $29.0 million, or 18.9% of net
loans receivable.  Commercial business loans generally include equipment loans
with terms ranging up to seven years and working capital lines of credit secured
by inventory and accounts receivable.  Commercial business loans are generally
made in amounts up to $100,000.  Unsecured lines of credit are made for up to
$300,000.  Working capital lines of credit are generally renewable and made for
a one-year term without a requirement that the borrower extinguish any
outstanding balance for a particular time period during the year.  Interest
rates on commercial business loans are generally indexed to the prime rate.  As
with commercial real estate loans, the Bank generally requires annual financial
statements from its commercial business borrowers and personal guarantees if the
borrower is a corporation.

          At December 31, 1998, the three largest commercial business loans had
outstanding balances of $1.0 million, $765,000 and $738,000 and were
collateralized by non-real estate business assets.  At December 31, 1998, each
loan was performing in accordance with its terms.

          Commercial business lending generally involves greater risk than
residential mortgage lending and involves risks that are different from those
associated with residential, commercial and multi-family real estate lending.
Real estate lending is generally considered to be collateral based lending with
loan amounts based on predetermined loan to collateral values and liquidation of
the underlying real estate collateral is viewed as the primary source of
repayment in the event of borrower default.  Although commercial business loans
are often collateralized by equipment, inventory, accounts receivable or other
business assets, the liquidation of collateral in the event of a borrower
default is often not a sufficient source of repayment because accounts
receivable may be uncollectible and inventories and equipment may be obsolete or
of limited use, among other things.  Accordingly, the repayment of a commercial
business loan depends primarily on the creditworthiness of the borrower (and any
guarantors), while liquidation of collateral is a secondary and often
insufficient source of repayment.

          At December 31, 1998, nonperforming (i.e. loans accounted for on a
nonaccrual basis and accruing loans contractually past due 90 days or more)
commercial business loans aggregated $1.2 million.

                                       7
<PAGE>
 
Loan Maturity

          The following table sets forth scheduled contractual amortization of
loans and mortgage-backed securities at December 31, 1998 and the dollar amount
of such securities and loans which are scheduled to mature after one year which
have fixed or adjustable interest rates.  Demand loans, loans having no stated
schedule of repayments and no stated maturity and overdraft loans are reported
as due in one year.  All loans held for sale are also reported as due within one
year.
<TABLE>
<CAPTION>
 
                                                             At December 31, 1998
                                          --------------------------------------------------------
                                                                Commercial             Mortgage-
                                            Mortgage  Consumer   Business    Total      Backed
                                             Loans     Loans       Loans     Loans     Securities
                                          ----------  --------  ----------  ---------  -----------
                                                              (In thousands)
<S>                                       <C>       <C>       <C>         <C>         <C>     
Amounts due:
   Within one year(1)....................  $ 28,449   $ 9,725     $20,050    $ 58,224      $112
   After one year through three years....    15,719     6,083       5,290      27,092       123
   After three years through five years..    18,193     4,878       3,206      26,277       177
   After five years......................    42,729     1,080         464      44,273       533
                                           --------   -------     -------    --------      ----                              
      Total..............................  $105,090   $21,766     $29,010    $155,866      $945
                                           ========   =======     =======    ========      ====
 
 
Interest rate terms on amounts
   due after one year:
   Fixed.................................  $ 35,456   $11,522     $ 6,233    $ 53,211      $764
   Adjustable............................    41,185       519       2,727      44,431        69
 
----------------------------
</TABLE>
(1)  Includes loans held for sale.

          Loan Solicitation and Processing.  Loan applicants come through direct
solicitation by Bank personnel and referrals by realtors and builders.  All
types of loans may be originated in the Bank's main office and in the
Rogersville and Muscle Shoals branch offices.  The Killen, Mall and Tuscumbia
branch offices do not provide loan origination services.  All loans are serviced
from the main office in Florence.  Applications for fixed-rate and adjustable-
rate mortgages on one- to four-family properties are underwritten and closed
based on Freddie Mac standards, and other loan applications are underwritten and
closed based on the Bank's own guidelines.  Residential mortgage loans are
required to have title insurance, as well as fire and extended coverage
insurance.  All mortgage loans require fire and extended coverage on appurtenant
structures.

          Upon receipt of a loan application from a prospective borrower, a
credit report and other data are obtained to verify specific information
relating to the loan applicant's employment, income and credit standing.  An
appraisal of the real estate offered as collateral is undertaken by a fee
appraiser approved by the Bank and licensed or certified by the State of
Alabama.

          Residential loans up to $300,000 may be approved by the President, the
Senior Lending Officer, the Senior Consumer Loan Officer or the Senior
Commercial Non-Real Estate Officer, with any two approving.  Secured consumer
and real estate commercial loans up to $200,000 and $300,000, respectively, may
also be approved by the President, the Senior Lending Officer, the Senior
Consumer Loan Officer, or the Senior Commercial Non-Real Estate Officer, with
any two approving.  Loans over $300,000 for one- to four-family residential
units; $400,000 for multi-family units; and $400,000 for commercial units must
be approved by the Bank's Loan/Investment Committee, which has the authority to
approve loans in the amount of $600,000 or less.  Loans in excess of $600,000
must be approved by the Bank's Board of Directors.

                                       8
<PAGE>
 
          Loan applicants are promptly notified of the decision of the Bank.
Interest rates are subject to change if the approved loan is not closed within
the time of the commitment.

          Loan Originations, Sales and Purchases.  The Bank originates fixed and
adjustable rate residential mortgage loans that meet or exceed the applicable
underwriting requirements of the FHLMC.  The Bank generally sells all FHA and VA
loans on a servicing released basis.  During the year ended December 31, 1998,
the Bank sold $23.3 million of loans, resulting in net gains on sale of
$263,000.  The total of loans serviced for others as of December 31, 1998 was
approximately $16.2 million.

          During the year ended December 31, 1998, the Bank's total mortgage
loan originations was $64.5 million, of which 24% was subject to periodic
interest rate adjustments and 76% was fixed-rate loans.

          The Bank purchases loan participation interests periodically.  At
December 31, 1998, the outstanding balance of purchased participation interests
was approximately $3.6 million and was secured by various commercial real
estate, one- to four-family residential and multi-family properties located in
Alabama and Tennessee.  At December 31, 1998, all of these participation
interests were current.

          The following table sets forth total mortgage loans originated,
purchased, sold and repaid during the years indicated.
<TABLE>
<CAPTION>
 
                                                                     Year Ended December 31,
                                                                 ------------------------------  
                                                                     1996       1997       1998
                                                                 --------   --------   -------- 
                                                                         (In thousands)
<S>                                                             <C>        <C>        <C>   
Total mortgage loans at beginning of period.............         $119,688   $118,639   $115,124
                                                                 --------   --------   --------  
Loans originated:                                          
   Single-family residential............................           17,820     27,707     38,175
   Multi-family residential and commercial real estate..           14,821     16,171     15,450
   Construction loans...................................            6,454      8,316     10,837
                                                                 --------   --------   --------  
      Total loans originated............................           39,095     52,194     64,462
                                                                 --------   --------   --------  
                                                           
Loans purchased:                                           
   Single-family residential............................               --         --         --
   Other................................................               --         --         --
                                                                 --------   --------   --------   
      Total loans purchased.............................               --         --         --
                                                                 --------   --------   --------   
         Total loans originated and purchased...........           39,095     52,194     64,462
                                                                 --------   --------   --------  
                                                           
Loans sold:                                                
   Total whole loans sold...............................           16,897     17,327     22,608
   Other................................................               --         --        683
                                                                 --------   --------   --------  
      Total loans sold..................................           16,897     17,327     23,291
                                                           
Mortgage loan principal repayments......................           22,319     37,593     49,207
Other (increase) decrease)..............................              928        789      1,998
                                                                 --------   --------   --------  
   Total net loan decreases.............................           40,144     55,709     74,496
                                                                 --------   --------   --------  
Net  loan activity......................................           (1,049)    (3,515)   (10,034)
                                                                 --------   --------   --------
                                                           
Total gross mortgage loans at end of period.............         $118,639   $115,124   $105,090
                                                                 ========   ========   ========   
</TABLE>

                                       9
<PAGE>
 
     Loan Commitments.  The Bank issues commitments for fixed- and adjustable-
rate single-family residential mortgage loans conditioned upon the occurrence of
certain events.  Such commitments are made in writing on specified terms and
conditions and are honored for up to 60 days from application.  A fee of 1% is
charged for each loan commitment.  At December 31, 1998, the Bank had $1.3
million of outstanding net loan commitments and $12.3 million of unused portions
on lines of credit, and $10,000 of outstanding letters of credit.  See Note 16
to Notes to Consolidated Financial Statements.

     Loan Origination and Other Fees.  The Bank, in most instances, receives
loan origination fees and discount "points."  Loan fees and points are a
percentage of the principal amount of the mortgage loan which are charged to the
borrower for funding the loan.  The amount of points charged by the Bank varies,
though the range generally is between 1 and 2 points.  Current accounting
standards require fees received (net of certain loan origination costs) for
originating loans to be deferred and amortized into interest income over the
contractual life of the loan.  Net deferred fees associated with loans that are
prepaid are recognized as income at the time of prepayment.  The Bank had
$69,000 of net deferred mortgage loan fees at December 31, 1998.

     Nonperforming Assets and Delinquencies.  When a mortgage loan borrower
fails to make a required payment when due, the Bank institutes collection
procedures.  The first notice is mailed to the borrower 15 days after the
payment due date with a late fee assessed the borrower and, if necessary, a
second written notice follows after 30 days.  After 45 days of the payment due
date, the Bank mails a letter to the borrower.  Attempts to contact the borrower
by telephone generally begin approximately 60 days after the payment due date.
If a satisfactory response is not obtained, continuous follow-up contacts are
attempted until the loan has been brought current.  In most cases, delinquencies
are cured promptly; however, if by the 90th day of delinquency, or sooner if the
borrower is chronically delinquent and all reasonable means of obtaining payment
on time have been exhausted, foreclosure, according to the terms of the security
instrument and applicable law, is initiated.  If management determines on the
90th day of delinquency that all remedies to cure the delinquency have been
exhausted, management classifies the loan nonaccrual and records the impairment,
if any, through the allowance for losses.

     If the borrower cannot be reached and does not respond to collection
efforts, a personal collection visit or property inspection is made.  The
physical condition and occupancy status of the property is determined before
recommending further servicing action.  Such inspection normally takes place
before the 90th day of delinquency.

     When a consumer loan borrower fails to make a required payment on a
consumer loan by the payment due date, the Bank institutes collection
procedures.  The first notice is mailed to the borrower 30 days following the
payment due date.  If necessary, a letter is mailed the following month.  The
customer is contacted by telephone to ascertain the nature of the delinquency
and is then notified in writing that counseling is available for eligible
borrowers.

     In most cases, delinquencies are cured promptly; however, if, by the 60th
day following the grace period of delinquency no progress has been made, a
written notice is mailed informing the borrowers of their right to cure the
delinquency within 90 days and of the Bank's intent to begin legal action if the
delinquency is not corrected.  Depending on the type of property held as
collateral, the Bank either obtains a judgment in small claims court or takes
action to repossess the collateral.

     The Bank's Board of Directors is informed monthly as to the status of all
loans delinquent 90 days or more, of all loans in foreclosure and of all
foreclosed and repossessed property owned by the Bank.

                                       10
<PAGE>
 
     The following table sets forth information with respect to the Bank's
nonperforming assets at the dates indicated.  At the dates indicated, the Bank
had no restructured loans within the meaning of Statement of Financial
Accounting Standards ("SFAS") No. 15.  At December 31, 1998, the Bank had
$484,000 of impaired loans within the meaning of SFAS No. 114.
<TABLE>
<CAPTION>
 
                                                          At December 31,
                                            -------------------------------------------
                                              1994     1995     1996     1997    1998
                                            -------  -------  -------  -------  ------- 
                                                      (Dollars in thousands)
<S>                                        <C>      <C>      <C>      <C>      <C>    
Loans accounted for on a nonaccrual basis:
   Real estate:
      One- to four-family.................  $   --   $   36   $   --   $   --    $  132
      Commercial..........................      --      270       --      401        --
   Commercial business....................      --       50       --      135       782
   Consumer...............................      --       --       18       25        --
                                            ------   ------   ------   ------    ------
         Total............................      --      356       18      561       914
                                            ------   ------   ------   ------    ------
                                                                                 
Accruing loans which were contractually                                          
   past due 90 days or more:                                                     
   Real estate:                                                                  
      One- to four-family.................     258      324      508      216     1,553
      Commercial..........................      --      770      489       --       243
      Construction........................      --       --      327       --       112
   Commercial business....................      19        3       39      148       432
   Consumer...............................      16       33       60      181       105
                                            ------   ------   ------   ------    ------
         Total............................     239    1,130    1,423      545     2,445
                                            ------   ------   ------   ------    ------
         Total of nonaccrual and 90 days                                         
            past due loans................     293    1,486    1,441    1,106     3,359 
Real estate owned.........................   1,073    1,098      198      100       710
                                            ------   ------   ------   ------    ------
         Total nonperforming assets.......  $1,366   $2,584   $1,639   $1,206    $4,069
                                            ======   ======   ======   ======    ======
Total loans delinquent 90 days                                                   
   or more to net loans...................    0.22%    0.98%    0.90%    0.69%     2.19% 
                                                                                 
Total loans delinquent 90 days                                                   
   or more to total assets................    0.19%    0.82%    0.78%    0.60%     1.88%  
                                                                                 
Total nonperforming assets                                                       
   to total assets........................    0.90%    1.43%    0.89%    0.66%     2.28% 
 
</TABLE>

     Real Estate Owned.  Real estate acquired by the Bank as a result of
foreclosure or by deed in lieu of foreclosure is classified as real estate owned
(foreclosed real estate) until it is sold.  When property is acquired it is
recorded at fair value at the time of foreclosure, less estimated costs of
disposal.  Subsequent to foreclosure, the property is carried at the lower of
the foreclosed amount or net realizable value.

     At December 31, 1998, the Bank had $710,000 of real estate owned, which
consisted of four single-family properties and one commercial property.

                                       11
<PAGE>
 
     Asset Classification.  In connection with examinations of insured
institutions, State of Alabama Banking Department and FDIC examiners have
authority to identify problem assets and, if appropriate, require them to be
classified.  There are three classifications for problem assets:  substandard,
doubtful and loss.  Substandard assets must have one or more defined weaknesses
and are characterized by the distinct possibility that the insured institution
will sustain some loss if the deficiencies are not corrected.  Doubtful assets
have the weaknesses of substandard assets with the additional characteristic
that the weaknesses make collection or liquidation in full on the basis of
currently existing facts, conditions and values questionable, and there is a
high possibility of loss.  An asset classified loss is considered uncollectible
and of such little value that continuance as an asset of the institution is not
warranted.  Special mention assets, described as assets which do not currently
expose an insured institution to a sufficient degree of risk to warrant
classification but do possess credit deficiencies or potential weaknesses
deserving management's close attention.  If an asset or portion thereof is
classified loss, the insured institution records a loss for the full amount of
the portion of the asset classified loss.  A portion of general loan loss
allowances established to cover possible losses related to assets classified
substandard or doubtful may be included in determining an institution's
regulatory capital.

     The Bank's senior officers meet monthly to review all classified assets, to
approve action plans developed to resolve the problems associated with the
assets and to review recommendations for new classifications, any changes in
classifications and recommendations for reserves.

     The Bank's classified assets are  as follows:
 
                               At December 31,
                              ----------------  
                                 1997     1998
                              --------  ------  
                                (In thousands)
 
Loss................          $    --   $   --
                                       
Doubtful............              566      484
                                       
Substandard assets..              473    2,975
                                       
Special mention.....            4,461    1,237
 

     At December 31, 1998, doubtful assets consisted primarily of impaired and
non-accrual commercial business loans; substandard assets consisted primarily of
delinquent single-family mortgage loans and delinquent commercial business
loans; and special mention assets consisted primarily of past due single-family
and commercial real estate loans.

     Allowance for Loan Losses.  The Bank has established a systematic
methodology for the determination of provisions for loan losses.  The
methodology is set forth in a formal policy and takes into consideration the
need for an overall general valuation allowance as well as specific allowances
that are tied to individual loans.  The allowance for loan losses is increased
by charges to income and decreased by charge-offs (net of recoveries).
Management's periodic evaluation of the adequacy of the allowance is based on
the Bank's past loan loss experience, known and inherent risks in the portfolio,
adverse situations that may affect the borrower's ability to repay the estimated
value of any underlying collateral, and current economic conditions.
Uncollectible interest on loans that are contractually past due is charged off,
or an allowance is established based on management's periodic evaluation.  The
allowance is established by a charge to interest income equal to all interest
previously accrued and unpaid, and 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.

     In originating loans, the Bank recognizes that losses will be experienced
and that the risk of loss will vary with among other things, the type of loan
being made, the creditworthiness of the borrower over the term of the loan,
general

                                       12
<PAGE>
 
economic conditions and, in the case of a secured loan, the quality of the
security for the loan.  The Bank increases its allowance for loan losses by
charging provisions for loan losses against the Bank's income.

     The general valuation allowance is maintained to cover yet unidentified
losses in the loan portfolio.  Management reviews the adequacy of the allowance
at least quarterly based on its knowledge of the portfolio including current
asset classifications, the Bank's write-off history, economic conditions
affecting the real estate markets and industry standards.

     Specific valuation allowances are established to absorb losses on loans for
which full collectibility may not be reasonably assured.  The amount of the
allowance is based on the estimated value of the collateral securing the loan
and other analysis pertinent to each situation.

     A provision for losses is charged against income periodically to maintain
the allowances.  At December 31, 1998, the Bank had allowances for loan losses
of $1.4 million which represented 0.94% of net loans receivable.

     Management believes that the amount maintained in the allowances will be
adequate to absorb losses in the portfolio.  Although management believes that
it uses the best information available to make such determinations, future
adjustments to the allowance for loan losses may be necessary and results of
operations could be significantly and adversely affected if circumstances differ
substantially from the assumptions used in making the determinations.

     Charge-offs occur when loans with specific reserves are impaired, in-
substance foreclosed, or foreclosed.  The specific reserve, along with any
additional amounts necessary to reduce the carrying value to fair market value,
net of estimated selling costs, is charged-off.  Foreclosed assets are
thereafter carried at the lower of the asset's newly established net fair value
or its net realizable value.  When a foreclosed asset is sold, any
excess/(deficiency) over the carrying value is reflected on the books as a
gain/(loss) on the sale of real estate owned.

     The Bank's market area is heavily concentrated in Lauderdale and Colbert
counties.  Real estate values have been stable to slightly increasing over the
past three years.  There can be no assurance as to the future performance of
real estate markets, including those in which the Bank primarily operates.  A
downturn in the Alabama real estate markets could have a material adverse effect
on the Bank's operations.  For example, depressed real estate values may result
in increases in nonperforming assets, hamper disposition of such nonperforming
assets and result in losses upon such disposition.

     While the Bank believes it has established its existing allowance for loan
losses in accordance with generally accepted accounting principles, there can be
no assurance that regulators, in reviewing the Bank's loan portfolio, will not
request the Bank to increase significantly its allowance for loan losses.  In
addition, because future events affecting borrowers and collateral cannot be
predicted with certainty, there can be no assurance that the existing allowance
for loan losses is adequate or that substantial increases will not be necessary
should the quality of any loans deteriorate as a result of the factors discussed
above.  Any material increase in the allowance for loan losses may adversely
affect the Bank's financial condition and results of operations.

                                       13
<PAGE>
 
     The following table sets forth an analysis of the Bank's gross allowance
for loan losses for the periods indicated.  Where specific loan loss reserves
have been established, any difference between the loss reserve and the amount
of loss actually realized has been charged or credited to current income.

<TABLE>
<CAPTION>
 
                                                        Year Ended December 31,
                                            -------------------------------------------
                                              1994     1995     1996     1997     1998
                                            ------   ------   ------   ------    ------                     
                                                         (Dollars in thousands)
<S>                                         <C>      <C>      <C>      <C>      <C> 
Allowance at beginning of period..........  $  801   $1,100   $1,509   $1,659    $1,584
                                            ------   ------   ------   ------    ------        
                                                                                 
Provision for loan losses.................     327      565      270      242       605
                                            ------   ------   ------   ------    ------        

Recoveries:                                                                      
   Residential real estate................      --       --       20        9        --
   Commercial business....................      --       --       70       17         1
   Consumer and other.....................       6       41       --        4        31
                                            ------   ------   ------   ------    ------        
      Total recoveries....................       6       41       90       30        32
                                            ------   ------   ------   ------    ------        
Chargeoffs:                                                                      
   Residential real estate................      --       (4)     (13)     (52)      (36)
   Commercial real estate.................      --       --      (25)    (185)       --
   Commercial business....................      --       --     (172)     (54)     (496)
   Consumer and other.....................     (34)    (193)      --      (56)     (248)
                                            ------   ------   ------   ------    ------
      Total chargeoffs....................     (34)    (197)    (210)    (347)     (780)
                                            ------   ------   ------   ------    ------
                                                                                 
      Net chargeoffs......................     (28)    (156)    (120)    (317)     (748)
                                            ------   ------   ------   ------    ------
                                                                                 
Balance at end of period..................  $1,100   $1,509   $1,659   $1,584    $1,441
                                            ======   ======   ======   ======    ======                                      
Ratio of allowance to net loans               
   outstanding at the end of the period...    0.84%    0.99%    1.04%    0.99%     0.94%                                    
                                                                                 
Ratio of net chargeoffs to average loans      
   outstanding during the period..........    0.02%    0.11%    0.08%    0.19%     0.49% 
 
</TABLE>

     The following table sets forth the Bank's allowance for loan losses by loan
category at the dates indicated.
<TABLE>
<CAPTION>
 
                                                                           At December 31,
                             -----------------------------------------------------------------------------------------------------
                                     1994                1995                 1996               1997                  1998    
                             -------------------  ------------------  ------------------  ------------------   -------------------
                                        As a %              As a %              As a %              As a %               As a %
                                        of Out-             of Out-             of Out-             of Out-              of Out-
                                        standing            standing            standing            standing             standing
                                        Loans in            Loans in            Loans in            Loans in             Loans in
                              Amount    Category   Amount   Category   Amount   Category   Amount   Category    Amount   Category
                             -------    --------  -------   --------  -------   --------  -------   --------   -------   -------- 
                                                                      (Dollars in thousands)                                  
<S>                          <C>      <C>        <C>      <C>        <C>      <C>        <C>      <C>          <C>        <C> 
Real estate mortgage loans:                                                                                 
   Residential.............   $  299      0.35%   $  331      0.39%   $  261      0.33%   $  234      0.34%     $  217      0.36%
   Other...................      334      1.25       441      1.25       167      0.43       210      0.46         188      0.41
Consumer and commercial                                                                                     
 business..................      467      2.00       729      2.00       580      1.29       614      1.29         651      1.28 
Unallocated................       --                   8                 651                 526                   385
                             -------              ------              ------              ------                ------
      Total allowance for     
       loan losses            $1,100              $1,509              $1,659              $1,584                $1,441 
                             =======              ======              ======              ======                ======
</TABLE>

                                       14
<PAGE>
 
Investment Activities

     The Bank has authority to invest in various types of liquid assets,
including United States Treasury obligations, securities of various federal
agencies and of state and municipal governments, deposits at the FHLB of
Atlanta, certificates of deposit of federally insured institutions, certain
bankers' acceptances and federal funds.

          The Bank is required under Alabama law to maintain at all times a
reserve (comprised of cash) based upon average daily deposits of the Bank.  At
December 31, 1998, the Bank's qualifying reserves of $1.7 million exceeded the
required reserve of $297,000.  The balance of the Bank's investments in short-
term securities in excess of regulatory requirements reflects management's
response to the significantly increasing percentage of deposits with short-term
maturities.  Management intends to hold securities with short-term maturities in
the Bank's investment portfolio in order to enable the Bank to provide liquidity
and to match more closely the interest-rate sensitivities of its assets and
liabilities.

          The Investment/Loan Committee, comprised of the two outside directors,
determines appropriate investments in accordance with the Board of Directors'
approved investment policies and procedures.  Investments are made following
certain considerations, which include the Bank's liquidity position and
anticipated cash needs and sources (which in turn include outstanding
commitments, upcoming maturities, estimated deposits, anticipated loan
amortization and repayments, and amortization of mortgage-backed securities).
Further, the effect that the proposed investment would have on the Bank's "gap"
position, credit and interest rate risk, and risk-based capital is given
consideration during the evaluation.  The interest rate, yield, settlement date
and maturity are also reviewed.

          At December 31, 1998, the Company's investment securities portfolio
totaled approximately $2.0 million at fair value ($2.0 million at amortized
cost) and, consisted of U.S. Treasury and agency securities.

          The Company also invests in mortgage-backed securities.  At December
31, 1998, the mortgage-backed securities portfolio had an amortized cost of
approximately $945,000 and as market value of $994,000, with maturities ranging
from six months to over ten years.  See Notes 3 and 4 of Notes to Consolidated
Financial Statements.

                                       15
<PAGE>
 
          The following table sets forth the cost and market values of the
investment securities portfolio at the dates indicated.
<TABLE>
<CAPTION>
 
                                                                    At December 31,
                              ---------------------------------------------------------------------------------------------------
                                              1996                           1997                           1998
                              -----------------------------   -------------------------------  ----------------------------------  
                                                   Percent                           Percent                             Percent
                              Amortized   Market     of       Amortized    Market      of       Amortized    Market        of
                               Cost(1)    Value   Portfolio    Cost(1)     Value    Portfolio   Cost(1)      Value      Portfolio
                              ---------  -------  ---------   --------   ---------  ---------  ---------   ---------    ---------
                                                                 (Dollars in thousands)                                    
<S>                          <C>        <C>        <C>        <C>        <C>         <C>       <C>         <C>         <C>      
Certificates of deposit....    $ 5,000   $ 5,000    45.41%    $    --    $      --        --%  $     --    $      --         --%
                                                                                                          
U.S. Government and agency                                                                                                       
   obligations.............      6,012     5,948    54.59       7,998        7,993    100.00      1,998        2,016     100.00 
                               -------   -------   ------     -------       ------    ------     ------       ------     ------ 
                                                                                                          
   Total...................    $11,012   $10,948   100.00%    $ 7,998       $7,993    100.00%    $1,998       $2,016     100.00%
                               =======   =======   ======     =======       ======    ======     ======       ======     ====== 
-----------------------
</TABLE>
(1) Percentage of portfolio value computed based upon carrying value of
    securities.  Prior to January 1, 1994, securities were recorded at amortized
    cost.  In 1994 the Company adopted the provisions of SFAS No. 115 under
    which the Company has classified 100% of its investment securities as
    "available for sale," which securities were therefore recorded at market
    value.

          The following table sets forth the maturities and weighted average
yields of the investment securities portfolio at December 31, 1998.

<TABLE>
<CAPTION>
 
                                                                          Weighted
                                                             Carrying      Average
                                                               Value       Yield
                                                            ---------     --------
                                                            (Dollars in thousands)
<S>                                                           <C>          <C>  
   U.S. government and agency obligations:
      Due in one year or less................                  $1,004       6.07%
      Due after one year through five years..                   1,012       5.91
                                                               ------     ------  
                                                               $2,016       5.99%
                                                               ======     ======
</TABLE>

                                       16
<PAGE>
 
          The following table sets forth the cost and market values of the
mortgage-backed securities portfolio at the dates indicated.
<TABLE>
<CAPTION>
 
                                                                    At December 31,
                               ----------------------------------------------------------------------------------------------------
                                              1996                             1997                              1998
                               --------------------------------- -------------------------------- ---------------------------------
                                                      Percent                        Percent                              Percent
                               Amortized  Market        of       Amortized  Market      of         Amortized  Market        of
                                  Cost    Value     Portfolio(1)    Cost    Value   Portfolio(1)     Cost     Value     Portfolio(1)
                               ---------  ------   ------------  ---------  ------  -----------    ---------  ------    -----------
                                                                     (Dollars in thousands)
<S>                           <C>        <C>       <C>           <C>        <C>      <C>           <C>        <C>       <C>   
FNMA certificates(2).......     $  256   $  264      13.57%       $  185    $  191      12.92%         $ 69    $ 78          7.30%
                                                                                                                           
GNMA certificates(2).......        818      855      43.35           587       613      40.99           402     426         42.54
                                                                                                                           
FHLMC certificates(2)......        813      836      43.08           660       681      46.09           474     490         50.16
                                ------   ------     ------        ------    ------     ------          ----    ----        ------
                                $1,887   $1,955     100.00%       $1,432    $1,485     100.00%         $945    $994        100.00%
                                ======   ======     ======        ======    ======     ======          ====    ====        ======
--------------------
</TABLE>
(1)  Percentage of portfolio value computed based upon amortized cost of
     mortgage-backed securities.
(2)  Classified as "held to maturity" at December 31, 1996, 1997 and 1998.


     The following table sets forth the maturities and weighted average yields
of the mortgage-backed securities portfolio at December 31, 1998.
<TABLE>
<CAPTION>
 
                                                             Weighted
                                                   Carrying   Average
                                                    Value      Yield
                                                  --------   --------
                                                 (Dollars in Thousands)
<S>                                              <C>       <C>  
Due in one year or less.................             $ 89      7.00%
Due after one year through five years...               26      8.31
Due after five years through ten years..              509      8.37
Due after ten years.....................              321      8.70
                                                     ----      ----   
                                                     $945      8.35%
                                                     ====      ====
</TABLE>

                                       17
<PAGE>
 
Deposit Activities and Other Sources of Funds

          General.  Deposits and loan repayments are the major sources of the
Bank's funds for lending and other investment purposes.  Scheduled loan
repayments are a relatively stable source of funds, while deposit inflows and
outflows and loan prepayments are influenced significantly 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 funds from other sources.
They may also be used on a longer-term basis for general business purposes.

          Deposit Accounts.  Deposits are attracted from within the Bank's
primary market area through the offering of a broad selection of deposit
instruments, including negotiable order of withdrawal ("NOW") accounts, money
market deposit accounts, statement savings accounts, certificates of deposit and
retirement savings plans.  Deposit account terms vary, according to the minimum
balance required, the time periods the funds must remain on deposit and the
interest rate, among other factors.  In determining the terms of its deposit
accounts, the Bank considers current market interest rates, profitability to the
Bank, matching deposit and loan products and its customer preferences and
concerns.  The Bank generally reviews its deposit mix and pricing weekly.

          In the unlikely event the Bank is liquidated depositors will be
entitled to full payment of their deposit accounts prior to any payment being
made to the Company, as stockholder of the Bank.  Substantially all of the
Bank's depositors are residents of the State of Alabama.

                                       18
<PAGE>
 
          The following table sets forth information concerning time deposits
and other interest-bearing and non-interest-bearing deposits at December 31,
1998.
<TABLE>
<CAPTION>
 
   Weighted                                                                               Percentage 
   Average                                                        Minimum                  of Total
Interest Rate    Term               Category                      Amount      Balance      Deposits
-------------  --------     ---------------------------          --------    --------      --------
                                                                           (In thousands)                  
<S>              <C>        <C>                                  <C>         <C>           <C> 
    0.00%        None       Non-interest bearing demand           $  100     $  5,939        4.66%
                                                                           
    2.00         None       NOW                                      500       11,757        9.22
                                                                           
    3.00         None       Money market demand                      500        3,421        2.68
                                                                           
    2.75         None       Passbook                                 100       15,415       12.09
                                                                           
    2.875        None       Statement savings                        100        2,300        1.80
 
 
                               Certificates of Deposit
                            ----------------------------
    3.92        91 days     Fixed-term, fixed rate                 1,000          165        0.13
                                                                           
    4.86        182 days    Fixed-term, fixed rate                 1,000       14,954       11.72
                                                                           
    5.18        1 year      Fixed-term, fixed rate                 1,000       21,522       16.87
                                                                           
    5.25        13 months   Fixed-term, fixed rate                 1,000        1,954        1.53
                                                                           
    5.55        14 months   Fixed-term, fixed rate                 1,000        9,348        7.33
                                                                           
    5.25        15 months   Fixed-term, fixed rate                 1,000           71        0.06
                                                                           
    5.18        18 months   Fixed-term, fixed rate                 1,000        1,353        1.06
                                                                           
    5.88        2 years     Fixed-term, fixed rate                 1,000       19,837       15.55
                                                                           
    5.47        30 months   Fixed-term, fixed rate                 1,000        2,549        2.00
                                                                           
    5.52        3 years     Fixed-term, fixed rate                 1,000        2,458        1.93
                                                                           
    6.16        4 years     Fixed-term, fixed rate                 1,000        1,347        1.06
                                                                           
    5.75        5 years     Fixed-term, fixed rate                 1,000        4,199        3.29
                                                                           
    7.75        6 years     Fixed-term, fixed rate                 1,000           81        0.06
                                                                           
    8.00        8 years     Fixed-term, fixed rate                 1,000          396        0.31
                                                                           
    5.24        1 year      Fixed-term, fixed rate                 1,000        2,913        2.28
                            individual retirement                            
                            account ("traditional IRA")                      
                                                                           
    4.84        1 year      Fixed-term, fixed rate                 1,000           32        0.03
                            individual retirement                            
                            account ("ROTH IRA")                             
                                                                           
    5.23        18 months   Fixed-term, fixed rate - IRA           1,000        5,539        4.34
                                                                             --------      ------
                                                                             $127,550      100.00%
                                                                             ========      ======
 
</TABLE>

     The following table indicates the amount of certificates of deposit and
other deposits with balances of $100,000 or greater by time remaining until
maturity as of December 31, 1998.  Other deposits with balances of $100,000 or
greater aggregated $4.4 million, and have been shown in the following table as
having maturities of three months or less.
<TABLE>
<CAPTION>
 
Maturity Period                 Amount
----------------                -------
                           (In thousands)
<S>                             <C> 
Three months or less            $ 6,846
Three through twelve months      10,229
Over twelve months                3,454
                                -------
     Total                      $20,529
                                =======
</TABLE>

                                       19
<PAGE>
 
<TABLE>
<CAPTION>
Deposit Flow

 
                                                                             At December 31,
                                       -------------------------------------------------------------------------------------------- 
                                                       1996                        1997                             1998
                                       ----------------------------   ------------------------------  -----------------------------
                                                 Percent                         Percent                         Percent            
                                                   of     Increase                 of      Increase                 of     Increase 
                                        Amount    Total   (Decrease)   Amount     Total   (Decrease)   Amount     Total   (Decrease)
                                       --------  -------  ---------   -------   --------  ----------  --------   -------   --------
                                                                               (Dollars in thousands)                        
<S>                                    <C>       <C>       <C>        <C>        <C>       <C>       <C>         <C>       <C>   
Noncertificate of deposit accounts(2):                                                                          
   Noninterest-bearing(1)..            $  4,189    3.15%    $ 1,951    $  4,119    2.87%   $   (70)    $  5,939    4.65%   $  1,820
   NOW checking............              10,744    8.09       1,006      11,015    7.66        271       11,757    9.22         742
   Regular savings accounts              17,839   13.44      (1,788)     15,918   11.08     (1,921)      15,415   12.09        (503)
   Money market deposit....               2,908    2.19         (80)      4,310    3.00      1,402        3,421    2.68        (889)
   Statement savings.......               1,486    1.12         701       1,400    0.97        (86)       2,300    1.80         900
                                                                                                                
Certificates of deposit(3)(4):                                                                                  
   Variable rate certificates which                                                                             
    mature:                                                                                                     
     Within one year.......               3,693    2.78         179          --      --     (3,693)          --      --          --
     Within three years....                  --      --      (3,273)         --      --         --           --      --          --
                                                                                                                
   Fixed-rate certificates which                                                                                
    mature:                                                                                                     
     Within one year.......              68,504   51.58       9,510      84,922   59.08     16,418       70,086   54.95     (14,836)
     Within three years....              23,351   17.58      (4,503)     20,923   14.56     (2,428)      15,678   12.29      (5,245)
     After three years.....                  86    0.07      (2,770)      1,124    0.78      1,038        2,954    2.32       1,830
                                       --------  ------     -------    --------  ------    -------     --------  --------  --------
     Total.................            $132,800  100.00%    $   933    $143,731  100.00%   $10,931     $127,550  100.00%   $(16,181)
                                       ========  ======     =======    ========  ======    =======     ========  ========  ========
----------------------------
</TABLE>
(1)  Comprised solely of NOW checking accounts.
(2)  Includes accounts with balances of $100,000 and greater of $1.4 million,
     $4.6 million and $4.4 million at December 31, 1996, 1997 and 1998,
     respectively.
(3)  Includes certificates of deposit with balances of $100,000 and greater of
     $15.2 million,$18.7 million and $16.1 million at December 31, 1996, 1997
     and 1998, respectively.
(4)  Includes IRA accounts of $8.0 million at December 31, 1996 and 1997, and
     $8.5 million at December 31, 1998.

                                       20
<PAGE>
 
Time Deposits by Rates

     The following table sets forth time deposits classified by rates as of the
dates indicated.
<TABLE>
<CAPTION>
 
                                                                  At December 31,
                                                        --------------------------------------
                                                           1996          1997           1998
                                                        ---------      --------        -------
                                                                     (In thousands)
<S>                                                     <C>            <C>             <C>    
                                                                                   
 2.01 - 4.00%.........................................    $   774      $    605        $   200
 4.01 - 5.00%.........................................        227           706         18,160
 5.01 - 6.00%.........................................     67,572        64,433         62,697
 6.01 - 7.00%.........................................     25,040        38,524          6,835
 7.01 or greater......................................      2,021         2,701            826
                                                          -------      --------        -------
   Total..............................................    $95,634      $106,969        $88,718
                                                          =======      ========        =======
 
</TABLE> 

  The following table sets forth the amount and maturities of time deposits at
   December 31, 1998.

<TABLE> 
<CAPTION>  
                                                                                                                       
                                                                                      Amount Due
                                                        --------------------------------------------------------------------------  
                                                                                                                         Percent
                                                                                                                         of Total   
                                                        Less Than     1-2        2-3      3-4      After               Certificate
                                                        One Year     Years      Years    Years    4 Years     Total      Accounts
                                                        ---------  ---------  --------  -------  ----------  --------  -----------
                                                                                 (Dollars in thousands)
<S>                                                     <C>        <C>        <C>       <C>      <C>         <C>        <C>    
2.00 - 4.00%..........................................    $   200    $    --  $     --  $    --   $     --    $   200       0.23%
4.01 - 5.00%..........................................     16,072      1,723       266       49          50    18,160      20.47
5.01 - 6.00%..........................................     48,360     10,513     2,065      271       1,488    62,697      70.67
6.01 - 7.00%..........................................      5,147      1,048        --      605          35     6,835       7.70
7.01 - or greater.....................................        307         63        --      385          71       826       0.93
                                                          -------    -------  --------  -------   ---------   -------     ------
    Total.............................................    $70,086    $13,347  $  2,331  $ 1,310   $   1,644   $88,718     100.00%
                                                          =======    =======  ========  =======   =========   =======     ======
</TABLE>

     The following table sets forth the deposit activities of the Bank for the
periods indicated.
<TABLE>
<CAPTION>
 
                                                 Years Ended December 31,
                                               ------------------------------
                                                 1996       1997      1998
                                               ---------  --------  ---------
                                                       (In thousands) 
<S>                                          <C>         <C>       <C>
                                            
Beginning balance....................          $131,867   $132,800  $143,731
                                               --------   --------  --------
Net increase (decrease)                     
 before interest credited............            (3,896)     5,798   (20,910)
Interest credited....................             4,829      5,133     4,729
                                               --------   --------  --------
Net increase (decrease)                     
 in savings deposits.................               933     10,931   (16,181)
                                               --------   --------  --------
Ending balance.......................          $132,800   $143,731  $127,550
                                               ========   ========  ========
 
</TABLE>

                                       21
<PAGE>
 
     Management attributes the net decrease in savings accounts in 1998
primarily to the maturity of higher rate certificates of deposit.  The Bank
declined to offer the same interest rates upon renewal, therefore, these
accounts were not renewed with the Bank.

     Borrowings.  Savings deposits are the primary source of funds for the
Bank's lending and investment activities and for its general business purposes.
The Bank may rely upon advances from the FHLB of Atlanta to supplement its
supply of lendable funds and to meet deposit withdrawal requirements.  The FHLB
of Atlanta has, from time to time, served as one of the Bank's primary borrowing
sources.  Advances from the FHLB of Atlanta are typically secured by the Bank's
first mortgage loans and certain investment and mortgage-backed securities.  At
December 31, 1998, the Bank had $31.3 million of borrowings from the FHLB of
Atlanta at a weighted average rate of 5.61%.  See Note 10 of Notes to
Consolidated Financial Statements.

     The FHLB of Atlanta functions as a central reserve bank providing credit
for savings and loan associations and certain other member financial
institutions.  As a member, the Bank is required to own capital stock in the
FHLB of Atlanta and is authorized to apply for advances on the security of such
stock and certain of its mortgage loans and other assets (principally securities
which are obligations of, or guaranteed by, the United States government)
provided certain creditworthiness standards have been met.  Advances are made
pursuant to several different credit programs.  Each credit program has its own
interest rate and range of maturities.  Depending on the program, limitations on
the amount of advances are based on the financial condition of the member
institution and the adequacy of collateral pledged to secure the credit.

     The following table sets forth certain information regarding short-term
borrowings by the Bank at the dates and for the periods indicated:
<TABLE>
<CAPTION>
 
                                                                Year Ended December 31,
                                                              ----------------------------
                                                                1996      1997      1998
                                                              --------  --------  --------
                                                                 (Dollars in thousands)
<S>                                                           <C>       <C>       <C>
Weighted average rate paid on:
FHLB advances...............................................     6.34%     6.00%     5.61%
Other borrowings(1).........................................     8.25        --        --
 
<CAPTION>  
                                                                 Year Ended December 31,
                                                              ---------------------------
                                                               1996       1997      1998
                                                              -------   -------   -------
                                                                (Dollars in thousands)
<S>                                                           <C>       <C>       <C>
Maximum amount of borrowings outstanding at any month end:
FHLB advances...............................................  $25,619   $36,043   $35,392
Other borrowings(1).........................................    4,000       450     1,600
 
Approximate average outstanding:
FHLB advances...............................................   21,934    26,221    30,231
Other borrowings(1).........................................      336       195       297
 
Approximate weighted average rate paid on:
FHLB advances...............................................     5.92%     5.88%     5.71%
Other borrowings(1).........................................     8.07      8.51      8.42%

</TABLE>

-----------------------
(1)  Credit facility from third party financial institution.

                                       22
<PAGE>
 
REGULATION

The Bank

     General.  As an Alabama-chartered, federally insured commercial bank, the
Bank is subject to extensive regulation.  Lending activities and other
investments must comply with various statutory and regulatory requirements,
including prescribed minimum capital standards.  The Bank is regularly examined
by the FDIC and the Superintendent and files periodic reports concerning the
Bank's activities and financial condition with its regulators.  The Bank's
relationship with depositors and borrowers also is regulated to a great extent
by both federal law and the laws of the State of Alabama, especially in such
matters as the ownership of savings accounts and the form and content of
mortgage documents.

     Federal and state banking laws and regulations govern all areas of the
operation of the Bank, including reserves, loans, mortgages, capital, issuance
of securities, payment of dividends and establishment of branches.  Federal and
state bank regulatory agencies also have the general authority to limit the
dividends paid by insured banks and bank holding companies if such payments
should be deemed to constitute an unsafe and unsound practice.  The respective
primary federal regulators of the Company and the Bank have authority to impose
penalties, initiate civil and administrative actions and take other steps
intended to prevent banks from engaging in unsafe or unsound practices.

     State Regulation and Supervision.  As a Alabama-chartered commercial bank,
the Bank is subject to applicable provisions of Alabama law and the regulations
of the Superintendent adopted thereunder.  Alabama law and regulations govern
the Bank's ability to take deposits and pay interest thereon, to make loans on
or invest in residential and other real estate, to make consumer loans, to
invest in securities, to offer various banking services to its customers, and to
establish branch offices.  The Bank is subject to periodic examination and
reporting requirements by and of the Superintendent.

     Deposit Insurance.  The FDIC insures deposits at the Bank to the maximum
extent permitted by law.  The Bank currently pays deposit insurance premiums to
the FDIC based on a risk-based assessment system established by the FDIC for all
SAIF-member institutions.  Under applicable regulations, institutions are
assigned to one of three capital groups which are based solely on the level of
an institution's capital --"well capitalized," "adequately capitalized," and
"undercapitalized" -- which are defined in the same manner as the regulations
establishing the prompt corrective action system under Section 38 of the Federal
Deposit Insurance Act ("FDIA"), as discussed below.  These three groups are then
divided into three subgroups which reflect varying levels of supervisory
concern, from those which are considered to be healthy to those which are
considered to be of substantial supervisory concern.  The matrix so created
results in nine assessment risk classifications, with rates currently ranging
from 0.23% for well capitalized, financially sound institutions with only a few
minor weaknesses to 0.31% for undercapitalized institutions that pose a
substantial risk of loss to the SAIF unless effective corrective action is
taken.  The FDIC is authorized to raise assessment rates in certain
circumstances.  The Bank's assessments expensed for the year ended December 31,
1998, equaled $83,000.

     The FDIC's current assessment schedule for SAIF deposit insurance provides
that the assessment rate for well-capitalized institutions with the highest
supervisory ratings would be reduced to zero and institutions in the lowest risk
assessment classification will be assessed at the rate of 0.27% of insured
deposits.  Until December 31, 1999, however, SAIF-insured institutions, will be
required to add to their assessments to the FDIC at the rate of 6.5 basis points
to help fund interest payments on certain bonds issued by the Financing
Corporation ("FICO"), an agency of the federal government established to finance
takeovers of insolvent thrifts.  During this period, BIF members will be
assessed for FICO obligations at the rate of 1.3 basis points.  After December
31, 1999, both BIF and SAIF members will be assessed at the same rate for FICO
payments.

     The FDIC may terminate the deposit insurance of any insured depository
institution if it determines after a hearing that the institution has engaged or
is engaging in unsafe or unsound practices, is in an unsafe or unsound
condition to continue operations, or has violated any applicable law,
regulation, order or any condition imposed by an 

                                       23
<PAGE>
 
agreement with the FDIC. It also may suspend deposit insurance temporarily
during the hearing process for the permanent termination of insurance, if the
institution has no tangible capital. If insurance of accounts is terminated, the
accounts at the institution at the time of termination, less subsequent
withdrawals, shall continue to be insured for a period of six months to two
years, as determined by the FDIC. Management is aware of no existing
circumstances which could result in termination of the deposit insurance of the
Bank.

     Prompt Corrective Action.  Each federal banking agency is required to
implement a system of prompt corrective action for institutions which it
regulates.  The federal banking agencies have promulgated substantially similar
regulations to implement this system of prompt corrective action.  Under the
regulations, an institution shall be deemed to be: (i) "well capitalized" if it
has a total risk-based capital ratio of 10.0% or more, has a Tier I risk-based
capital ratio of 6.0% or more, has a Tier I leverage capital ratio of 5.0% or
more and is not subject to specified requirements to meet and maintain a
specific capital level for any capital measure; (ii) "adequately capitalized" if
it has a total risk-based capital ratio of 8.0% or more, a Tier I risk-based
capital ratio of 4.0% or more and a Tier I leverage capital ratio of 4.0% or
more (3.0% under certain circumstances) and does not meet the definition of
"well capitalized;" (iii) "undercapitalized" if it has a total risk-based
capital ratio that is less than 8.0%, a Tier I risk-based capital ratio that is
less than 4.0% or a Tier I leverage capital ratio that is less than 4.0% (3.0%
under certain circumstances); (iv) "significantly undercapitalized" if it has a
total risk-based capital ratio that is less than 6.0%, a Tier I risk-based
capital ratio that is less than 3.0% or a Tier I leverage capital ratio that is
less than 3.0%; and (v) "critically undercapitalized" if it has a ratio of
tangible equity to total assets that is equal to or less than 2.0%.

     A federal banking agency may, after notice and an opportunity for a
hearing, reclassify a well capitalized institution as adequately capitalized and
may require an adequately capitalized institution or an undercapitalized
institution to comply with supervisory actions as if it were in the next lower
category if the institution is in an unsafe or unsound condition or engaging in
an unsafe or unsound practice.  (The FDIC may not, however, reclassify a
significantly undercapitalized institution as critically undercapitalized.)

     An institution generally must file a written capital restoration plan which
meets specified requirements, as well as a performance guaranty by each company
that controls the institution, with the appropriate federal banking agency
within 45 days of the date that the institution receives notice or is deemed to
have notice that it is undercapitalized, significantly undercapitalized or
critically undercapitalized.  Immediately upon becoming undercapitalized, an
institution shall become subject to various mandatory and discretionary
restrictions on its operations.

     At December 31, 1998, the Bank was categorized as "well capitalized" under
the prompt corrective action regulations of the FDIC.

     Standards for Safety and Soundness.  The federal banking regulatory
agencies are required, by regulation, to prescribe standards for all insured
depository institutions relating to: (i) internal controls, information systems
and internal audit systems; (ii) loan documentation; (iii) credit underwriting;
(iv) interest rate risk exposure; (v) asset growth; and (vi) compensation, fees
and benefits.  The federal banking agencies recently adopted final regulations
and Interagency Guidelines Prescribing Standards for Safety and Soundness
("Guidelines") to implement safety and soundness standards.  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 agencies also proposed asset quality and earnings
standards which, if adopted in final, would be added to the Guidelines.  Under
the final regulations, if the FDIC determines that the Bank fails to meet any
standard prescribed by the Guidelines, the agency may require the Bank to submit
to the agency an acceptable plan to achieve compliance with the standard.  The
final regulations establish deadlines for the submission and review of such
safety and soundness compliance plans.

     Capital Requirements.  The FDIC's minimum capital standards applicable to
FDIC-regulated banks and savings banks require the most highly-rated
institutions to meet a "Tier 1" leverage capital ratio of at least 3% of total
assets.  Tier 1 (or "core capital") consists of common stockholders' equity,
noncumulative perpetual preferred stock and minority interests in consolidated
subsidiaries minus all intangible assets other than limited amounts of purchased

                                       24
<PAGE>
 
mortgage servicing rights and certain other accounting adjustments. All other
banks must have a Tier 1 leverage ratio of at least 100 to 200 basis points
above the 3% minimum. The FDIC capital regulations establish a minimum leverage
ratio of not less than 4% for banks that are not highly rated or are
anticipating or experiencing significant growth. Based on the definitions
contained in the FDIC's capital regulations, the Bank had a Tier 1 leverage
capital ratio of 9.69% as of December 31, 1998.

     The FDIC's capital regulations require higher capital levels for banks
which exhibit more than a moderate degree of risk or exhibit other
characteristics which necessitate that higher than minimum levels of capital be
maintained.  Any insured bank with a Tier 1 capital to total assets ratio of
less than 2% is deemed to be operating in an unsafe and unsound condition unless
the insured bank enters into a written agreement, to which the FDIC is a party,
to correct its capital deficiency. Insured banks operating with Tier 1 capital
levels below 2% (and which have not entered into a written agreement) are
subject to an insurance removal action. Insured banks operating with lower than
the prescribed minimum capital levels generally will not receive approval of
applications submitted to the FDIC. Also, inadequately capitalized state
nonmember banks will be subject to such administrative action as the FDIC deems
necessary.

     FDIC regulations also require that banks meet a risk-based capital
standard.  The risk-based capital standard requires the maintenance of total
capital (which is defined as Tier 1 capital and Tier 2 or supplementary capital)
to risk weighted assets of 8% and Tier 1 capital to risk-weighted assets of 4%.
In determining the amount of risk-weighted assets, all assets, plus certain off
balance sheet items, are multiplied by a risk-weight of 0% to 100%, based on the
risks the FDIC believes are inherent in the type of asset or item.  The
components of Tier 1 capital are equivalent to those discussed above under the
3% leverage requirement.  The components of supplementary capital currently
include cumulative perpetual preferred stock, adjustable-rate perpetual
preferred stock, mandatory convertible securities, term subordinated debt,
intermediate-term preferred stock and allowance for possible loan and lease
losses.  Allowance for possible loan and lease losses includable in
supplementary capital is limited to a maximum of 1.25% of risk-weighted assets.
Overall, the amount of capital counted toward supplementary capital cannot
exceed 100% of Tier 1 capital.  Since September 1995, the FDIC includes in its
evaluation of a bank's capital adequacy an assessment of the exposure to
declines in the economic value of the bank's capital due to changes in interest
rates.  However, no measurement framework for assessing the level of a bank's
interest rate risk exposure has been codified.  In the future, the FDIC will
issue a proposed rule that would establish an explicit minimum capital charge
for interest rate risk, based on the level of a bank's measured interest rate
risk exposure.

     FDIC capital requirements are designated as the minimum acceptable
standards for banks whose overall financial condition is fundamentally sound,
which are well-managed and have no material or significant financial weaknesses.
The FDIC capital regulations state that, where the FDIC determines that the
financial history or condition, including off-balance sheet risk, managerial
resources and/or the future earnings prospects of a bank are not adequate and/or
a bank has a significant volume of assets classified substandard, doubtful or
loss or otherwise criticized, the FDIC may determine that the minimum adequate
amount of capital for that bank is greater than the minimum standards
established in the regulation.

     Activities and Investments of Insured State-Chartered Banks.  Federal law
generally limits the activities and equity investments of FDIC-insured, state-
chartered banks to those that are permissible for national banks.  Under
regulations dealing with equity investments, an insured state bank generally may
not directly or indirectly acquire or retain any equity investment of a type, or
in an amount, that is not permissible for a national bank.  An insured state
bank is not prohibited from, among other things, (i) acquiring or retaining a
majority interest in a subsidiary, (ii) investing as a limited partner in a
partnership the sole purpose of which is direct or indirect investment in the
acquisition, rehabilitation or new construction of a qualified housing project,
provided that such limited partnership investments may not exceed 2% of the
bank's total assets, (iii) acquiring up to 10% of the voting stock of a company
that solely provides or reinsures directors', trustees' and officers' liability
insurance coverage or bankers' blanket bond group insurance coverage for insured
depository institutions, and (iv) acquiring or retaining the voting shares of a
depository institution if certain requirements are met.

                                       25
<PAGE>
 
     In addition, an insured state bank (i) that is located in a state which
authorized as of September 30, 1991 investment in common or preferred stock
listed on a national securities exchange ("listed stock") or shares of a
registered investment company ("registered shares"), and (ii) which during the
period beginning September 30, 1990 through November 26, 1991 ("measurement
period") made or maintained investments in listed stocks and registered shares,
may retain whatever shares that were lawfully acquired or held prior to December
19, 1991 and continue to acquire listed stock and registered shares, provided
that the bank does not convert its charter to another form or undergo a change
in control.  In order to acquire or retain any listed stock or registered
shares, however, the bank must file a one-time notice with the FDIC which meets
specified requirements and which sets forth the bank's intention to acquire and
retain stocks or shares, and the FDIC must determine that acquiring or retaining
the listed stocks or registered shares will not pose a significant risk to the
deposit insurance fund of which the bank is a member.

     FDIC regulations provide that an insured state-chartered bank may not,
directly, or indirectly through a subsidiary, engage as "principal" in any
activity that is not permissible for a national bank unless the FDIC has
determined that such activities would pose no risk to the insurance fund of
which it is a member and the bank is in compliance with applicable regulatory
capital requirements.  Any insured state-chartered bank directly or indirectly
engaged in any activity that is not permitted for a national bank must cease the
impermissible activity.

     Loans-to-One-Borrower.  Under Alabama law the aggregate amount of loans
that the Bank is permitted to make to any one borrower, including related
entities, is generally 20% of the Bank's capital account (i.e., capital, surplus
and undivided profits) provided that loans in excess of 10% of the capital
account are fully secured.  At December 31, 1998, the Bank's loans-to-one
borrower limit was approximately $3.5 million.  At December 31, 1998, the
largest aggregate amount of loans by the Bank to any one borrower was
approximately $3.3 million, which was comprised of  six loans ($419,000 in one-
to four-family loans, $2.3 million in commercial real estate loans,  $279,000
outstanding under a $350,000 line of credit secured by commercial real estate,
and $205,000 outstanding under a $224,000 line of credit secured by a single-
family residence), all of which were performing according to their terms.

     Federal Reserve System.  Regulation D of the FRB requires all depository
institutions that maintain transaction accounts or nonpersonal time deposits.
These reserves may be in the form of cash or non-interest-bearing deposits with
the regional Federal Reserve Bank.  NOW accounts and other types of accounts
that permit payments or transfers to third parties fall within the definition of
transaction accounts and are subject to Regulation D reserve requirements, as
are any nonpersonal time deposits at a bank.  Under Regulation D, a bank must
establish reserves equal to 3% of the first $43.1 million of transaction
accounts, of which the first $4.7 million is exempt, and 10% on the remainder.
The reserve requirement on nonpersonal time deposits with original maturities of
less than 1-1/2 years is 0%.  As of December 31, 1998, the Bank met its reserve
requirements.

     Affiliate Transactions. The Company and the Bank are separate and distinct
legal entities.  Various legal limitations restrict the Bank from lending or
otherwise supplying funds to the Company (an "affiliate"), generally limiting
such transactions with the affiliate to 10% of the bank's capital and surplus
and limiting all such transactions to 20% of the bank's capital and surplus.
Such transactions, including extensions of credit, sales of securities or assets
and provision of services, also must be on terms and conditions consistent with
safe and sound banking practices, including credit standards, that are
substantially the same or at least as favorable to the bank as those prevailing
at the time for transactions with unaffiliated companies.

     Federally insured banks are subject, with certain exceptions, to certain
restrictions on extensions of credit to their parent holding companies or other
affiliates, on investments in the stock or other securities of affiliates and on
the taking of such stock or securities as collateral from any borrower.  In
addition, such banks are prohibited from engaging in certain tie-in arrangements
in connection with any extension of credit or the providing of any property or
service.

     Community Reinvestment Act.  Banks are also subject to the provisions of
the Community Reinvestment Act of 1977, which requires the appropriate federal
bank regulatory agency, in connection with its regular examination of a bank, to
assess the bank's record in meeting the credit needs of the community serviced
by the bank, including low 

                                       26
<PAGE>
 
and moderate income neighborhoods. The regulatory agency's assessment of the
bank's record is made available to the public. Further, such assessment is
required of any bank which has applied, among other things, to establish a new
branch office that will accept deposits, relocate an existing office or merge or
consolidate with, or acquire the assets or assume the liabilities of, a
federally regulated financial institution. The Bank received an "outstanding"
CRA rating as a result of its most recent evaluation.

     Dividends.  Dividends from the Bank constitute the major source of funds
for dividends which may be paid by the Company.  The amount of dividends payable
by the Bank to the Company depend upon the Bank's earnings and capital position,
and is limited by federal and state laws, regulations and policies.  According
to Alabama law, the Bank is required to transfer to surplus each year at least
10% of its net earnings (and thus cannot declare or pay a dividend in excess of
90% of net earnings) until its surplus equals at least 20% of its capital.
Furthermore, the Bank must obtain the approval of the Superintendent to declare
dividends in any calendar year in excess of the total of its net earnings of
that year combined with its retained net earnings of the preceding to years,
less any required transfers to surplus.

     At the time of the consummation of the Stock Conversion, OTS regulations
required the Association to establish a liquidation account for the benefit of
eligible account holders of the Association.  This liquidation account was
assumed by the Bank at the time of the consummation of the Bank Conversion.  The
Bank may not declare or pay a cash dividend on any of its capital stock that
would reduce the Bank's regulatory capital below the amount required for the
liquidation account.  See Note 20 of the Notes to Consolidated Financial
Statements.

     Federal law further provides that no insured depository institution may
make any capital distribution (which would include a cash dividend) if, after
making the distribution, the institution would be "undercapitalized," as defined
in the prompt corrective action regulations.  Moreover, the federal bank
regulatory agencies also have the general authority to limit the dividends paid
by insured banks if such payments should be deemed to constitute an unsafe and
unsound practice.

The Holding Company

     General.  The Company, as the sole shareholder of the Bank, is a bank
holding company registered as such with the FRB.  Bank holding companies are
subject to comprehensive regulation by the FRB under the Bank Holding Company
Act of 1956, as amended ("BHCA") and the regulations of the FRB.  As a bank
holding company, the Company is required to file with the FRB annual reports and
such additional information as the FRB may require and is subject to regular
examinations by the FRB.  The FRB also has extensive enforcement authority over
bank holding companies, including, among other things, the ability to assess
civil money penalties, to issue cease and desist or removal orders and to
require that a holding company divest subsidiaries (including its bank
subsidiaries).  In general, enforcement actions may be initiated for violations
of law and regulations and unsafe or unsound practices.

     Under the BHCA, a bank holding company must obtain FRB approval before: (1)
acquiring, directly or indirectly, ownership or control of any voting shares of
another bank or bank holding company if, after such acquisition, it would own or
control more than 5% of such shares (unless it already owns or controls the
majority 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.

     Any direct or indirect acquisition by a bank holding company or its
subsidiaries of more than 5% of the voting shares of, or substantially all of
the assets of, any bank located outside of the state in which the operations of
the bank holding company's banking subsidiaries are principally conducted, may
not be approved by the FRB unless the laws of the state in which the bank to be
acquired is located specifically authorize such an acquisition.  Most states
have authorized interstate bank acquisitions by out-of-state bank holding
companies on either a regional or a national basis, and most such statutes
require the home state of the acquiring bank holding company to have enacted a
reciprocal statute. Alabama law permits bank holding companies located in the
states of Alabama, Arkansas, Florida, Georgia, Kentucky, Louisiana, Maryland,
Mississippi, North Carolina, South Carolina, Tennessee, Texas, Virginia and West

                                       27
<PAGE>
 
Virginia and the District of Columbia to acquire banks or bank holding companies
located in Alabama subject to the requirements that the laws of the state in
which the acquiring bank holding company is located permit bank holding
companies located in Alabama to acquire banks or bank holding companies in the
acquiror's state and that the Alabama bank sought to be acquired has been in
existence for at least five years. Since September 30, 1995, federal law permits
well capitalized and well managed bank holding companies to acquire control of
an existing bank in any state.

     The BHCA also prohibits a bank holding company, with certain exceptions,
from acquiring direct or indirect ownership or control of more than 5% of the
voting shares of any company that is not a bank or bank holding company and from
engaging directly or indirectly in activities other than those of banking,
managing or controlling banks, or providing services for its subsidiaries.
Under the BHCA, the FRB is authorized to approve the ownership of shares by a
bank holding company in any company, the activities of which the FRB has
determined to be so closely related to the business of banking or managing or
controlling banks as to be a proper incident thereto.  The list of activities
determined by regulation to be closely related to banking within the meaning of
the BHCA includes, among other things:  operating a savings institution,
mortgage company, finance company, credit card company or factoring company;
performing certain data processing operations; providing certain investment and
financial advice; underwriting and acting as an insurance agent for certain
types of credit-related insurance; leasing property on a full-payout, non-
operating basis; selling money orders, travelers' checks and U.S. Savings Bonds;
real estate and personal property appraising; providing tax planning and
preparation services; and, subject to certain limitations, providing securities
brokerage services for customers.

     Dividends.  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.  The FRB also indicated that it
would be inappropriate for a company experiencing serious financial problems to
borrow funds to pay dividends.  Furthermore, under the prompt corrective action
regulations adopted by the FRB, the FRB may prohibit a bank holding company from
paying any dividends if the holding company's bank subsidiary is classified as
"undercapitalized" under the prompt corrective action regulations.

     Bank holding companies, except for certain "well-capitalized" bank holding
companies, are required to give the FRB prior written notice of any purchase or
redemption of its outstanding equity securities if the gross consideration for
the purchase or redemption, when combined with the net consideration paid for
all such purchases or redemptions during the preceding 12 months, is equal to
10% or more of their consolidated net worth.  The FRB may disapprove such a
purchase or redemption of it determines that the proposal would constitute an
unsafe or unsound practice or would violate any law, regulation, FRB order, or
any condition imposed by, or written agreement with, the FRB.

     Capital Requirements.  The FRB has established capital adequacy guidelines
for bank holding companies that generally parallel the capital requirements of
the FDIC for the Bank.  The FRB regulations provide that capital standards will
be applied on a consolidated basis in the case of a bank holding company with
$150 million or more in total consolidated assets.  At December 31, 1998, the
Company met its minimum regulatory capital requirements.  See Notes 14 to Notes
to Consolidated Financial Statements.

                                       28
<PAGE>
 
                                    TAXATION

Federal Taxation

          General.  The Company and the Bank report their income on a fiscal
year basis using the accrual method of accounting.  The Company and the Bank are
subject to federal income taxation in the same manner as other corporations with
some exceptions, including particularly the Bank's reserve for bad debts
discussed below.  The following discussion of tax matters is intended only as a
summary and does not purport to be a comprehensive description of the tax rules
applicable to the Company and the Bank.

          Bad Debt Reserve.  In years prior to the consummation of the Bank
Conversion, the Association, as a qualified thrift meeting certain eligibility
criteria prescribed in the Code, was able to determine its tax basis bad debt
reserve using the percentage of taxable income method ("PTI Method") set forth
in the Code.  The Association's use of the PTI Method resulted in a
significantly greater tax basis reserve for bad debts than that recognized for
financial reporting purposes.

          Upon consummation of the Bank Conversion, the Bank became a "former
thrift institution" and, as such, under provisions of the Code, is no longer
eligible to maintain its tax basis bad debt reserve on the PTI Method.  As a
financial institution with total assets less than $500 million, the Bank is
permitted to maintain its tax basis bad debt reserves on the experience method
("Experience Method"), which computes a tax basis bad debt reserve based upon a
six-year weighted-average calculation of actual bad debts experienced by the
Bank.

          Under applicable provisions of the Code, on a ratable basis over a
six-year period commencing in 1995, the Bank must include in income the excess
of the PTI Method bad debt reserve as of December 31, 1994 over its newly
adopted Experience Method tax basis reserve determined as of December 31, 1994.
See Note 11 of Notes to Consolidated Financial Statements.

          In the event that the Bank's assets ever exceed the $500 million
threshold, the Bank would be required to recapture its newly adopted Experience
Method tax basis bad debt reserve in increasing increments over a four-year
period.  Thereafter, the Bank would be required to use the direct or specific
charge-off method applicable to large banks in calculating the Bank's tax bad
debt deduction.  Under the direct or specific charge-off method, the Bank would
be entitled to a bad debt deduction only in the taxable year in which a specific
debt become worthless or is shown to be recoverable only in part.

          The Bank Conversion occurred prior to the enactment of the Small
Business Job Protection Act of 1996 which repealed the PTI method but did not
require recapture of pre-1988 bad debt reserves.

          Distributions.  To the extent that the Bank makes "nondividend
distributions" to shareholders, such distributions will be considered to result
in distributions from the balance of its bad debt reserve as of December 31,
1987 (or a lesser amount if the Bank's loan portfolio decreased since December
31, 1987) and then from the supplemental reserve for losses on loans ("Excess
Distributions"), and an amount based on the Excess Distributions will be
included in the Bank's taxable income.  Nondividend distributions include
distributions in excess of the Bank's current and accumulated earnings and
profits, distributions in redemption of stock and distributions in partial or
complete liquidation.  However, dividends paid out of the Bank's current or
accumulated earnings and profits, as calculated for federal income tax purposes,
will not be considered to result in a distribution from the Bank's bad debt
reserves.

          The amount of additional taxable income created from and Excess
Distribution is an amount that, when reduced by the tax attributable to the
income, is equal to the amount of the distribution.  Thus, approximately one and
one-half times the Excess Distribution would be includable in gross income for
federal income tax purposes, assuming a 34%

                                       29
<PAGE>
 
federal corporate income tax rate.  See "REGULATION" for limits on the payment
of dividends by the Bank.  The Bank does not intend to pay dividends that would
result in a recapture of any portion of its tax bad debt reserve.

          Corporate Alternative Minimum Tax.  The Code imposes a tax on
alternative minimum taxable income ("AMTI") at a rate of 20%.  AMTI is increased
by an amount equal to 75% of the amount by which the Bank's adjusted current
earnings exceeds its AMTI (determined without regard to this preference and
prior to reduction for net operating losses).  For taxable years beginning after
December 31, 1986, and before January 1, 1996, an environmental tax of 0.12% of
the excess of AMTI (with certain modification) over $2.0 million is imposed on
corporations, including the Bank, whether or not an Alternative Minimum Tax
("AMT") is paid.  Under President Clinton's 1998 budget proposal, the corporate
environmental income tax would be reinstated for taxable years beginning after
December 31, 1996 and before January 1, 2008.

          Dividends-Received Deduction and Other Matters.  The Holding Company
may exclude from its income 100% of dividends received from the Bank as a member
of the same affiliated group of corporations.  The corporate dividends-received
deduction is generally 70% in the case of dividends received from unaffiliated
corporations with which the Holding Company and the Bank will not file a
consolidated tax return, except that if the Holding Company or the Bank owns
more than 20% of the stock of a corporation distributing a dividend, then 80% of
any dividends received may be deducted.

          Audits.  The Company's and the Bank's federal income tax returns have
been audited through 1996.

State Taxation

          Alabama Taxation.  The State of Alabama imposes a 6% excise tax on the
Bank's earnings.  The Alabama Department of Revenue has conducted one audit of
the Bank's financial institutions excise tax returns during the last five years
resulting in minor adjustments which increased the Bank's tax liability by less
than $8,000.

          Delaware.  As a Delaware holding company not earning income in
Delaware, the Company is exempt from Delaware corporate income tax, but is
required to file an annual report with and pay an annual franchise tax to the
State of Delaware.

Competition

          The Bank faces strong competition in the attraction of savings
deposits (its primary source of lendable funds) and in the origination of real
estate and consumer loans.  Its most direct competition for savings deposits and
loans has historically come from other thrift institutions and from commercial
banks located in its primary market area in Lauderdale and Colbert counties of
the State of Alabama.  The Bank competes for loans primarily through the
interest rates and loan fees it charges, and the prompt, efficient, and quality
service it provides to its borrowers, real estate brokers, and home builders.
Primary competition for loans are from other thrift institutions, commercial
banks, mortgage banking companies, insurance companies, and credit unions.

Personnel

          As of December 31, 1998, the Bank had 66 full-time and 12 part-time
employees.  The employees are not represented by a collective bargaining unit.
The Bank believes its relationship with its employees is good.

Executive Officers

          The executive officers of the Company, each of whom holds the same
positions with the Bank, are:

                                       30
<PAGE>
 
<TABLE> 
<CAPTION> 

Name                            Position
----                            --------
<S>                             <C> 
Charles L. Frederick, Jr.       President, Chief Executive Officer and Director

William E. Batson               Chairman of the Board

Thomas N. Ward                  Executive Vice President/Chief Operating Officer and Director

</TABLE> 
          The principal occupation of each executive officer of the Bank is set
forth below.  Unless otherwise noted, all officers have held the position
described below for at least the past five years.

          Charles L. Frederick, Jr. has been employed with the Bank since 1965
and has served as President and Chief Executive Officer since 1988.

          William E. Batson is a self-employed public accountant.

          Thomas N. Ward has been employed by the Bank since 1977 serving in
various capacities and has served as Executive Vice President/Chief Operating
Officer since 1991.

Item 2.  Properties
-------------------

          The following table sets forth certain information regarding the
Bank's offices as of December 31, 1998.  The net book value of the Bank's
investment in office, properties and equipment totaled $3.9 million at December
31, 1998.
<TABLE>
<CAPTION>
                                                 Year      Building        Land        Building
Location                           County       Opened   Owned/Leased  Owned/Leased  Square Footage     Deposits
--------                         ----------    --------  ------------  ------------  --------------     --------
                                                                                                     (In thousands)
<S>                              <C>           <C>       <C>           <C>           <C>             <C>
 
Main Office
-----------
102 South Court Street           Lauderdale      1935       Owned         Owned           45,000         $74,852
Florence, Alabama  35630                                                                              
                                                                                                      
Branch Offices                                                                                        
--------------                                                                                        
U.S. Highway 72 E.               Lauderdale      1977       Owned         Owned            1,890          11,533
Killen, Alabama  35645                                                                                
                                                                                                      
U.S. Highway 72 E.               Lauderdale      1977       Owned         Owned            1,890          12,170
Rogersville, Alabama  35652                                                                           
                                                                                                      
2727 Mall Drive                  Lauderdale      1979       Owned         Owned            1,216          20,505
Florence, Alabama  35630                                                                              
                                                                                                      
1027 Avalon Avenue               Colbert         1990       Owned         Owned            3,500           6,159
Muscle Shoals, Alabama  35661                                                                         
                                                                                                      
506 N. Main Street               Colbert         1998       Owned         Owned            2,500           2,331
Tuscumbia, Alabama 35674
</TABLE>

                                       31
<PAGE>
 
Item 3.  Legal Proceedings
--------------------------

          Periodically, there have been various claims and lawsuits involving
the Bank, mainly as a defendant, such as claims to enforce liens, condemnation
proceedings on properties in which the Bank holds security interests, claims
involving the making and servicing of real property loans and other issues
incident to the Bank's business.  The Bank is not a party to any pending legal
proceedings that it believes would have a material adverse effect on the
financial condition or operations of the Bank.

Item 4.  Submission of Matters to a Vote of Security Holders
------------------------------------------------------------

          No matters were submitted to a vote of security holders during the
fourth quarter of the fiscal year ended December 31, 1998.


                                    PART II

Item 5.   Market for the Registrant's Common Equity and Related Stockholder
-------   -----------------------------------------------------------------
Matters
-------

          The information contained in the section captioned "Market for First
Southern Bancshares, Inc.'s Common Stock and Related Stockholder Matters" in the
Annual Report is incorporated herein by reference.

Item 6.   Management's Discussion and Analysis of Financial Condition and
-------   ---------------------------------------------------------------
Results of Operation
--------------------

          The information contained in the section captioned "Management's
Discussion and Analysis of Financial Condition and Results of Operations" in the
Annual Report is incorporated herein by reference.

Item 7.  Financial Statements
-----------------------------

          Independent Auditors' Report*
          Consolidated Statements of Financial Condition, December 31, 1997 and
          1998*
          Consolidated Statements of Income For the Years Ended December 31, 
          1996, 1997 and 1998*
          Consolidated Statements of Changes in Shareholders' Equity For the 
          Years Ended December 31, 1996, 1997 and 1998*
          Consolidated Statements of Cash Flows For the Years Ended December 31,
          1996, 1997 and 1998*
          Notes to Consolidated Financial Statements*
          -------------
          * Contained in the Annual Report to Stockholders filed as an exhibit
          hereto and incorporated herein by reference. All schedules have been
          omitted as the required information is either inapplicable or
          contained in the Consolidated Financial Statements or related Notes
          contained in the Annual Report to Stockholders.

Item 8.  Changes in and Disagreements With Accountants on Accounting and
------------------------------------------------------------------------
Financial Disclosure
--------------------

          No disagreement with the Company's independent accountants on
accounting and financial disclosure has occurred during the two most recent
fiscal years.

                                       32
<PAGE>
 
                                 PART III

Item 9.   Directors, Executive Officers, Promoters and Control Persons;
          Compliance with Section 16(a) of the Exchange Act
--------------------------------------------------------------------------------

          The information contained under the section captioned "Proposal I --
Election of Directors" in the Proxy Statement is incorporated herein by
reference.  For information concerning the executive officers of the Bank, see
"Item I -- Business -- Executive Officers."  The information contained under the
section captioned "Compliance With Section 16(a) of the Exchange Act" in the
Proxy Statement is incorporated herein by reference.

Item 10.  Executive Compensation
--------------------------------

          The information contained under the section captioned "Proposal I --
Election of Directors" 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 Security
              Ownership of Certain Beneficial Owners and Management" 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
              Security Ownership of Certain Beneficial Owners and Management"
              and "Proposal I --Election of Directors" of the Proxy Statement.

          (c) Changes in Control

              The Company is not aware of any arrangements, including any pledge
              by any person of securities of the Company, the operation of which
              may at a subsequent date result in a change in control of the
              Company.

Item 12.  Certain Relationships and Related Transactions
--------------------------------------------------------

          The information required by this item is incorporated herein by
reference to the section captioned "Proposal I -- Election of Directors --
Certain Transactions."

                                       33
<PAGE>
 
                                    PART IV

Item 13.  Exhibits, List Reports on Form 8-K
--------------------------------------------

    (a)  Exhibits

         (3a)   Certificate of Incorporation of the Company*
         (3b)   Bylaws of the Company*
         (10a)  1996 Stock Option Plan of the Company**
         (10b)  1996 Management Recognition and Development Plan of the
                Company**
         (10c)  Employment Agreement with Charles L. Frederick, Jr.***
         (10d)  Employment Agreement with Thomas N. Ward***
         (13)   Annual Report to Stockholders
         (21)   Subsidiaries of the Registrant
         (27)   Financial Data Schedule
         --------------
         *   Incorporated by reference to the Company's Registration Statement
             on Form S-1, as subsequently amended.
         **  Incorporated by reference to the Company's Proxy Statement for the
             1998 Annual Meeting of Stockholders.
         *** Incorporated by reference to the Company's Annual Report on Form
             10-KSB for the year ended December 31, 1995.

    (b)  Report on Form 8-K

         No Forms 8-K were filed during the quarter ended December 31, 1998.

                                       34
<PAGE>
 
                                   SIGNATURES

    Pursuant to the requirements of section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.

                               FIRST SOUTHERN BANCSHARES, INC.


Date:  March 31, 1999          By: /s/Charles L. Frederick, Jr.
                                  -----------------------------
                                  Charles L. Frederick, Jr.
                                  President, Chief Executive Officer and 
                                   Director
                                  (Duly Authorized Representative)

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

 
By: /s/ Charles L. Frederick, Jr.                                March 31, 1999
   --------------------------------------------------           
   Charles L. Frederick, Jr.                                    
   President, Chief Executive Officer and Director              
   (Principal Executive Officer and Principal                   
   Financial Officer)                                           
                                                                
By: /s/ Thomas N. Ward                                           March 31, 1999
   ---------------------------------------------------
   Thomas N. Ward
   Executive Vice President and Chief Operating Officer
   (Principal Accounting Officer)
 
By: /s/ William E. Batson                                        March 31, 1999
   --------------------------
   William E. Batson
   Chairman of the Board
 
By: /s/ James E. Bishop                                          March 31, 1999
   --------------------------    
   James E. Bishop
   Director
 
By: /s/ Milka S. Duke                                            March 31, 1999
   --------------------------
   Milka S. Duke
   Director
 
By: /s/ Gary A. Gamble                                           March 31, 1999
   --------------------------
   Gary A. Gamble
   Director
  
By: /s/ J. Acker Rogers                                          March 31, 1999
   --------------------------
   J. Acker Rogers
   Director
 
By: /s/ Kenneth A. Williams                                      March 31, 1999
   --------------------------
   Kenneth A. Williams
   Director
 
By: /s/ Steve McKinney                                           March 31, 1999
   --------------------------
   Steve McKinney
   Director
 
By: /s/ S. Greg Beadle                                           March 31, 1999
   --------------------------
   S. Greg Beadle
   Director

                                       35