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

                                   FORM 10-KSB
                                  ANNUAL REPORT

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


     Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the fiscal year ended December 31, 1998        Commission File No. 000-21383

                          Appalachian Bancshares, Inc.
                 (Name of Small Business Issuer in Its Charter)

        Georgia                                        58-2242407
(State of Incorporation)                 (I.R.S. Employer Identification Number)

       829 Industrial Boulevard                            30540
           Ellijay, Georgia                              (Zip Code)
(Address of Principal Executive Offices)

                                 (706) 276-8000
                (Issuer's Telephone Number, Including Area Code)

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

         Securities registered under Section 12(b) of the Exchange Act:

Title of Each Class                        Name of Exchange on Which Registered
-------------------                        ------------------------------------
      None                                                 N/A

         Securities registered under Section 12(g) of the Exchange Act:

                     Common Stock, $5.00 par value per share

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

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

         The issuer's revenues for its most recent fiscal year were $11,799,913.

         There is no established trading market for the registrant's capital
stock. The aggregate market value of the stock held by non-affiliates of the
registrant at March 29, 1999 was $18,456,760, based on a per share price of
$20.00, which is the price of the last trade of which management is aware as of
such date. Although directors and executive officers of the registrant were
assumed to be "affiliates" of the registrant for purposes of this calculation,
the classification is not to be interpreted as an admission of such status.

         At March 29, 1999, there were 1,323,188 shares of the registrant's
Common Stock outstanding.

         Transitional Small Business Disclosure Format (check one): Yes |_|
No |X|

Documents Incorporated by Reference

         Portions of the registrant's definitive Proxy Statement for the 1999
Annual Meeting of Shareholders are incorporated by reference into Part III of
this Report.


<PAGE>   2


                          APPALACHIAN BANCSHARES, INC.
                         1998 Form 10-KSB Annual Report


                                TABLE OF CONTENTS



<TABLE>
<CAPTION>
  Item Number                                                                                           Page or
in Form 10-KSB                                          Description                                     Location
--------------                                          -----------                                     --------

<S>                       <C>                                                                           <C>
      Item 1.             Business...............................................................            1

      Item 2.             Properties.............................................................           24

      Item 3.             Legal Proceedings......................................................           25

      Item 4.             Submission of Matters to a Vote of Security Holders....................           25

      Item 5.             Market for the Registrant's Common Equity and Related Shareholder
                          Matters................................................................           26

      Item 6.             Management's Discussion and Analysis of Financial
                          Condition and Results of Operations....................................           27

      Item 7.             Financial Statements...................................................          F-1

      Item 8.             Changes in and Disagreements with Accountants on Accounting and
                          Financial Disclosure...................................................           40

      Item 9.             Directors, Executive Officers, Promoters and Control
                          Persons; Compliance with Section 16(a) of the
                          Exchange Act...........................................................           41

      Item 10.            Executive Compensation.................................................           41

      Item 11.            Security Ownership of Certain Beneficial Owners
                          and Management.........................................................           41

      Item 12.            Certain Relationships and Related Transactions.........................           41

      Item 13.            Exhibits, List and Reports on Form 8-K.................................           41
</TABLE>

                                       i
<PAGE>   3





                                     PART I

             CAUTIONARY NOTICE REGARDING FORWARD-LOOKING STATEMENTS

         Certain of the statements made in this Report and in documents
incorporated by reference herein, including matters discussed under the caption
"Management's Discussion and Analysis of Financial Condition and Results of
Operations," as well as oral statements made by the Company or its officers,
directors or employees, may constitute forward-looking statements within the
meaning of Section 21E of the Securities Exchange Act of 1934, as amended (the
"Exchange Act"). Such forward-looking statements are based on Management's
beliefs, current expectations, estimates and projections about the financial
services industry, the economy and about the Company and the Banks in general.
The words "expect," "anticipate," "intend," "plan," "believe," "seek,"
"estimate" and similar expressions are intended to identify such forward-looking
statements; however, this Report also contains other forward-looking statements
in addition to historical information. Such forward-looking statements are not
guarantees of future performance and are subject to risks, uncertainties and
other factors that may cause the actual results, performance or achievements of
the Company to differ materially from historical results or from any results
expressed or implied by such forward-looking statements. Such factors include,
without limitation, (i) increased competition with other financial institutions,
(ii) lack of sustained growth in the economy in Gilmer County, primarily in the
local poultry industry, and in Union County (iii) rapid fluctuations in interest
rates, (iv) the inability of the Banks (as defined herein) to maintain
regulatory capital standards, and (v) changes in the legislative and regulatory
environment. Many of such factors are beyond the Company's ability to control or
predict, and readers are cautioned not to put undue reliance on such
forward-looking statements. The Company disclaims any obligation to update or
revise any forward-looking statements contained in this Report, whether as a
result of new information, future events or otherwise.


Item 1.   Business

History and Development of the Company

          Appalachian Bancshares, Inc. (the "Company" or "Registrant") is a bank
holding company which engages in providing a full range of banking services
through its two commercial bank subsidiaries: Gilmer County Bank and First
National Bank of Union County (the Company's two bank subsidiaries are
collectively referred to as the "Banks"). The Company was incorporated as a
business corporation in May 1996 under the laws of the State of Georgia for the
purpose of acquiring 100% of the issued and outstanding shares of common stock
of Gilmer County Bank. In July 1996, the Company received approval from the
Federal Reserve Bank of Atlanta (the "Federal Reserve") and the Georgia
Department of Banking and Finance ("DBF") to become a bank holding company. In
August 1996, the Company and Gilmer County Bank entered into a reorganization
(the "Reorganization") pursuant to which the Company acquired 100% of the
outstanding shares of Gilmer County Bank, and the shareholders of Gilmer County
Bank became the shareholders of the capital stock of the Company.

         On November 30, 1998, the Company completed an acquisition of First
National Bank of Union County ("First National") from Century South Banks, Inc.
("Century South"). First National is a nationally-chartered bank organized in
1981 with its main banking office located in Blairsville, Georgia. Pursuant to
the terms of the acquisition agreement, the Company acquired First National, in
a cash transaction, for a purchase price of $6.1 million, with the assumption of
certain existing liabilities and assets of First National by Century South or
certain of its affiliates. The Company funded a portion of the purchase price
with the proceeds of a private placement of 132,500 shares of the Company's
Common Stock to certain accredited investors. The aggregate gross proceeds of
the private placement were $2.65 million. Purchasers of shares of the Company's
Common Stock in the private placement are entitled to certain registration
rights with respect to such shares and are subject to certain call rights of the
Company. The Company funded the remainder of the purchase price through a new
$3.6 million loan with The Bankers Bank.


                                       1
<PAGE>   4

         At December 31, 1998, the assets of the Company consisted primarily of
its ownership of the capital stock of the Banks. Unless otherwise indicated, the
information presented herein relating to the Company refers to the Company and
the Banks on a consolidated basis.

         The Company's executive office is located at 829 Industrial Boulevard,
Ellijay, Georgia, and its telephone number at such location is (706) 276-8000.

Business of the Company

         The Company is authorized to engage in any activity permitted by law to
a corporation, subject to applicable federal and state regulatory restrictions
on the activities of bank holding companies. The Company's holding company
structure provides it with greater flexibility than the respective Banks would
otherwise have to expand and diversify their business activities through newly
formed subsidiaries, or through acquisitions. While management of the Company
has no present plans to engage in any other business activities, management may
from time to time study the feasibility of establishing or acquiring
subsidiaries to engage in other business activities to the extent permitted by
law.

Gilmer County Bank

         Gilmer County Bank was organized in 1994 under the laws of the State of
Georgia to conduct a commercial banking business in Gilmer County, Georgia, with
its deposits insured by the Federal Deposit Insurance Corporation ("FDIC").
Gilmer County Bank was formed to meet the banking needs of individuals, small-
to medium-sized businesses, and farmers, especially those engaged in apple and
poultry production.

         Gilmer County Bank was organized by a group of individuals from Gilmer
County and the surrounding area and commenced business from its main office
location at 829 Industrial Boulevard, Ellijay, Georgia on March 3, 1995. Gilmer
County Bank operated in development stage prior to that time.

         Gilmer County Bank has a correspondent relationship with several banks,
including The Bankers Bank, Federal Home Loan Bank and Compass Bank.

First National Bank of Union County

         First National Bank was organized in 1981 as an insured national bank
chartered under the federal banking laws of the United States of America. First
National is a member of the Federal Reserve System and is subject to the
supervision of the Office of the Comptroller of the Currency (the "OCC"). First
National's deposits are insured by the FDIC.

         First National conducts business from its main banking office located
in Blairsville, Georgia. First National has a correspondent relationship with
several banks, including The Bankers Bank, Federal Home Loan Bank and Compass
Bank.

Subsequent Event

         On March 12, 1999, the Company received approval from the DBF to
convert First National into a state-chartered bank under the laws of the State
of Georgia. The Company is currently in the process of converting First National
into a state-chartered bank. The Company anticipates that it will complete the
conversion in the second quarter of 1999. Concurrently, with the conversion of
First National, the Company plans to change First National's name to Appalachian
Community Bank.



                                       2
<PAGE>   5

Banking Services and Operations

          The Banks perform banking services customary for full service banks of
similar size and character. Such services include the receipt of demand and time
deposit accounts, the extension of personal and commercial loans and the
furnishing of personal and commercial checking accounts. Gilmer County Bank
draws most of its customer deposits and conducts most of its lending
transactions from and within a primary service area encompassing Gilmer County,
southwestern Fannin County, northern Pickens County, western Dawson County and
southeastern Murray County, Georgia. First National draw most of its customer
deposits and conducts most of its lending transactions from and within a primary
service area which includes Union County, Towns County and Fannin County,
Georgia.

         The principal business of the Banks is to attract and accept deposits
from the public and to make loans and other investments. The principal sources
of funds for the Banks' loans and investments are (1) demand, time, savings, and
other deposits (including negotiable order of withdrawal ("NOW") accounts), (2)
amortization and prepayment of loans granted, (3) sales to other lenders or
institutions of loans or participation in loans, (4) fees paid by other lenders
or institutions for servicing loans sold by the Banks to such lenders or
institutions and (5) borrowings. The principal sources of income for the Banks
are interest and fees collected on loans, including fees received for servicing
loans sold to other lenders or institutions and, to a lesser extent, interest
and dividends collected on other investments. The principal expenses of the
Banks are (1) interest paid on savings and other deposits (including NOW
accounts), (2) interest paid on borrowings by the Banks, (3) employee
compensation, (4) office expenses and (5) other overhead expenses.

Employees

         Except for the officers of the Company, who are also officers of the
Banks, the Company does not have any employees. At December 31, 1998, Gilmer
County Bank had a total of 41 employees, 37 of which were full-time employees,
and First National had a total of 24 employees, 22 of which were full-time
employees. The Company and the Banks are not parties to any collective
bargaining agreements with employees, and management believes that employee
relations are generally good.

Lending Activities

         General. The Banks are authorized to make both secured and unsecured
commercial and consumer loans to individuals, partnerships, corporations and
other entities. The Banks' lending business consists principally of making
secured real estate loans, including residential and commercial construction
loans, and primary and secondary mortgage loans for the acquisition or
improvement of personal residences. In addition, the Banks make consumer loans
to individuals and commercial loans to small and medium-sized businesses and
professional concerns. Loans to the poultry industry constituted approximately
18% of the Banks' total loans at December 31, 1998.

         The Banks have engaged in secondary-market mortgage activities,
obtaining commitments, through intermediaries, from secondary mortgage
purchasers to purchase mortgage loans originated by the Banks. Based on these
commitments, the Banks originate mortgage loans on terms corresponding to such
commitments and generates fee income to supplement its interest income. No
mortgage loans are held by the Banks for resale nor are any loans held for
mortgage servicing.

         Real Estate Loans. Loans secured by real estate are the primary
component of the Banks' loan portfolio, constituting approximately $88 million,
or 67%, of the Banks' total loans at December 31, 1998. These loans consist of
commercial real estate loans, construction and development loans and residential
real estate loans but exclude home equity loans, which are classified as
consumer loans.

         Commercial Loans. The Banks make loans for commercial purposes in
various lines of businesses. At December 31, 1998, the Banks held approximately
$27 million, or 21% of the Banks' total loans, in commercial loans, excluding
for these purposes commercial loans secured by real estate which are included in
the real estate category above.



                                       3
<PAGE>   6

         Consumer Loans. The Banks make a variety of loans to individuals for
personal and household purposes, including secured and unsecured installment and
term loans, home equity loans and lines of credit, and revolving lines of credit
such as credit cards. At December 31, 1998, the Banks held approximately $14
million in consumer loans, representing 11% of the Banks' total loans.

         Loan Approval and Review. The Banks' loan approval policies provide for
various levels of officer lending authority. When the aggregate outstanding
loans to a single borrower exceeds that individual officer's lending authority,
the loan request must be considered and approved by an officer with a higher
lending limit or the officers' loan committee. Individual officers' lending
limits range from $15,000 to $100,000, depending on seniority and type of loan.
The officers' loan committee, which consists of the president, executive vice
president and senior lending officer, has a lending limit of $150,000 for
secured loans. Loans between $150,000 and $300,000 must be approved by a
directors' loan committee, which is made up of the president, the senior lending
officer and three outside directors. Loans above $300,000 require approval by
the majority of the full Board of Directors.

         Each of the Banks has a continuous loan review procedure involving
multiple officers of each of the respective Banks which is designed to promote
early identification of credit quality problems. All loan officers are charged
with the responsibility of rating their loans and reviewing those loans on a
periodic basis, the frequency of which increases as the quality of the loan
decreases. The Banks' have employed an in-house specialist to review all loans
in excess of $100,000.

Deposits

         The Banks offer a variety of deposit programs to individuals and to
small to medium-sized businesses and other organizations at interest rates
generally consistent with local market conditions. The Banks are authorized to
accept and pay interest on deposits from individuals, corporations, partnerships
and any other type of legal entity, including fiduciaries (such as private
trusts). Qualified deposits are insured by the FDIC in an amount up to $100,000.

         The following table sets forth the mix of depository accounts at the
Banks as a percentage of total deposits at December 31, 1998.

                                   Deposit Mix

<TABLE>
<CAPTION>
                                                                                      December 31, 1998
                                                                                      -----------------
         <S>                                                                          <C> 
         Non-interest bearing demand............................................              5.7%
         Interest-bearing demand................................................             29.3%
         Savings................................................................             17.7%
         Time Deposits..........................................................             31.5%
         Certificates of Deposit of $100,000 or more............................             15.8%
            Total...............................................................            100.0%
</TABLE>

         Both of the Banks are members of the Cirrus ATM network of automated
teller machines, which permits the Banks' customers to perform certain
transactions in numerous cities throughout Georgia and in other states. Gilmer
County Bank's charter provides that Gilmer County Bank has trust powers but only
upon application to the DBF. To date, Gilmer County Bank has not submitted and
has no plans to submit such an application. First National does not have trust
powers.



                                       4
<PAGE>   7

Competition and Market Area

         The banking business is highly competitive. The Banks compete as
financial intermediaries with other commercial banks, thrift institutions,
credit unions, and money market mutual funds operating in Ellijay, Gilmer County
and Blairsville, Union County, Georgia and elsewhere. Some banks with which the
Banks compete have significantly greater resources and higher lending limits (by
virtue of their greater capitalization). Credit unions and money market mutual
funds with which the Banks compete may have competitive advantages as a result
of being subject to different, and possibly less stringent, regulatory
requirements.

         Gilmer County Bank serves the areas of Gilmer County, southwestern
Fannin County, northern Pickens County, western Dawson County and southeastern
Murray County, Georgia. First National serves the areas of Union County, Towns
County and Fannin County, Georgia.

         As of December 31, 1998, three non-locally owned banks had offices in
Gilmer County and two locally owned banks had offices in Blairsville. The Bank
of Ellijay, which is owned by Century South Banks, Inc., a bank holding company
headquartered in Gainesville, Georgia, operates a main office and one branch
office in Gilmer County. RegionsBank, an Alabama bank holding company, operates
two offices in Gilmer County. United Community Bank, a branch of Peoples Bank in
Fannin County, maintains a branch office in Gilmer County. Bank of Blairsville,
a branch of Bank of Hiawassee, operates an office in Blairsville. Union County
Bank, headquartered in Blairsville, operates an office in Blairsville. In
addition, many local businesses and individuals have deposits outside the
primary service areas of Gilmer County Bank and First National.

         Recent legislation enacted by the Georgia General Assembly allow banks
in Georgia to establish de novo branch banks in areas in which the Banks serve,
which branches, if established, would also compete with the Banks. See
"Supervision and Regulation--Regulation and Legislative Changes."

Monetary Policies

         The results of operations of the Company and the Banks are
significantly affected by the credit policies of monetary authorities,
particularly the Board of Governors of the Federal Reserve System. The
instruments of monetary policy employed by the Federal Reserve include open
market operations in U.S. government securities, changes in discount rates on
member bank borrowings, and changes in reserve requirements against bank
deposits. In view of changing conditions in the national economy and in the
money markets, as well as the effect of action by monetary and fiscal
authorities, including the Federal Reserve System, no prediction can be made as
to possible future changes in interest rates, deposit levels, loan demand, or
the business and earnings of the Banks.


                           SUPERVISION AND REGULATION

         The Company and the Banks are subject to state and federal banking laws
and regulations which impose specific requirements or restrictions and provide
for general regulatory oversight with respect to virtually all aspects of
operations. These laws and regulations are generally intended to protect
depositors, not stockholders. To the extent that the following summary describes
statutory or regulatory provisions, it is qualified in its entirety by reference
to the particular statutory and regulatory provisions. Any change in applicable
laws or regulations may have a material effect on the business and prospects of
the Company. Beginning with the enactment of the Financial Institutions Reform,
Recovery and Enforcement Act of 1989 ("FIRREA") and following with the Federal
Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA"), numerous
additional regulatory requirements have been placed on the banking industry in
the past five years, and additional changes have been proposed. The operations
of the Company and the Banks may be affected by legislative changes and the
policies of various regulatory authorities. The Company is unable to predict the
nature or the extent of the effect on its business and earnings that fiscal or
monetary policies, economic control or new federal or state legislation may have
in the future.


                                       5
<PAGE>   8

The Company

         The Company is a bank holding company within the meaning of the federal
Bank Holding Company Act of 1956, as amended (the "BHC Act"), and is registered
with and subject to the regulation of the Federal Reserve under the BHC Act. As
a bank holding company, the Company is required to file with the Federal Reserve
annual reports and such other reports and information as may be required under
the BHC Act. The Federal Reserve may conduct examinations of the Company and the
Banks to determine whether such institutions are in compliance with the
regulations promulgated under the BHC Act.

         The BHC Act requires a bank holding company to obtain prior approval of
the Federal Reserve (i) before it may acquire directly or indirectly the
ownership or control of more than 5% of any class of voting stock of any bank
not already controlled by it, (ii) before it or any subsidiary (other than a
bank) may acquire all or substantially all of the assets of a bank, and (iii)
before it may merge or consolidate with any other bank holding company. The
Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 (the
"Interstate Banking Act") facilitates branching and permits the establishment of
agency relationships across state lines and permits bank holding companies to
acquire banks in any state without regard to whether the transaction is
prohibited under the laws of such state, subject to certain state provisions,
including minimum age requirements of banks that are the target of the
acquisition. The minimum age of local banks subject to interstate acquisition is
limited to a maximum of five years. See "--Regulation and Legislative Changes."

         Bank holding companies are also generally prohibited under the BHC Act
from engaging in non-banking activities or acquiring direct or indirect control
of any company engaged in non-banking activities. However, the Federal Reserve
may permit bank holding companies to engage in certain non-banking activities
found by the Federal Reserve to be so closely related to banking or managing or
controlling banks as to be a proper incident thereto. Such activities determined
by the Federal Reserve to fall under this category include, but are not limited
to, making or servicing loans and certain leases, providing certain data
processing services, acting as a fiduciary or investment or financial advisor,
providing discount brokerage services, underwriting bank eligible securities,
and making investments designed to promote community welfare.

         The Federal Reserve Act imposes certain limitations on extensions of
credit and other transactions by and between banks that are members of the
Federal Reserve System and other affiliates (which includes any holding company
of which such bank is a subsidiary and any other non-bank subsidiary of such
holding company). Banks that are not members of the Federal Reserve System are
also subject to these limitations. Further, federal law prohibits a bank holding
company and its subsidiaries from engaging in certain tie-in arrangements in
connection with any extension of credit, lease or sale of property, or the
furnishing of services.

         Under Federal Reserve policy, a bank holding company is expected to act
as a source of financial strength to its bank subsidiaries and to commit
resources to support such subsidiaries. This support may be required at times
when, absent such policy, the bank holding company might not otherwise provide
such support. Under these provisions, a bank holding company may be required to
loan money to its subsidiary banks in the form of capital notes or other
instruments which qualify for capital under regulatory rules. Any loans by the
bank holding company to such subsidiary banks are likely to be unsecured and
subordinate to such bank's depositors and possibly to other creditors of such
bank.

         The Company is also subject to regulation as a bank holding company
under the Georgia Financial Institutions Code (the "Code"), which requires
registration and filing of periodic information with the DBF. Registration with
the DBF includes information relating to the financial condition, operations,
management and inter-company relationships of the Company and the Banks. The DBF
may also require such other information or make examinations as is necessary to
keep itself informed as to whether the Company is in compliance with the
provisions of Georgia law and the regulations and orders promulgated or issued
thereunder.

         Under the provisions of the Code, it is unlawful without the prior
approval of the DBF (i) for any bank holding company to acquire direct or
indirect ownership or control of more than 



                                       6
<PAGE>   9

5% of the voting shares of the Banks; (ii) for any bank holding company or a
subsidiary thereof (other than a bank) to acquire all or substantially all of
the assets of a bank; or (iii) for any bank holding company to merge or
consolidate with any other bank holding company. It is also unlawful under the
Code for any bank holding company to acquire direct or indirect ownership or
control of more than 5% of the voting shares of any presently operating bank
unless such bank has been in existence and continuously operating or
incorporated as a bank for a period of five years or more prior to the date of
application to the DBF for approval of such acquisition. In addition, in any
such acquisition by an existing bank holding company, the initial banking
subsidiary of such bank holding company must have been incorporated for not less
than two years before the holding company can acquire another bank.

The Banks

         Gilmer County Bank is a banking institution incorporated under the laws
of the State of Georgia and subject to examination by the DBF. The DBF regulates
all areas of Gilmer County Bank's commercial banking operations, including
reserves, loans, mergers, consolidations, reorganizations, issuance of
securities, payment of dividends, interest rates, establishment of branches, and
other aspects of its operations.

         First National is a national banking association and a member of the
Federal Reserve System. The OCC is the primary regulator for the Bank. The OCC
regulates or monitors all areas of the Bank's operations, including security
devices and procedures, adequacy of capitalization and loss reserves, loans,
investments, borrowings, deposits, mergers, issuances of securities, payment of
dividends, interest rates payable on deposits, interest rates or fees chargeable
on loans, establishment of branches, corporate reorganizations, maintenance of
books and records and adequacy of staff training to carry on safe lending and
deposit gathering practices. The Bank must maintain certain capital ratios and
is subject to limitations on aggregate investments in real estate, bank
premises, and furniture and fixtures.

         Additionally, each of the Banks is insured and regulated by the FDIC.
The major functions of the FDIC with respect to insured banks include paying off
depositors to the extent provided by law in the event a bank is closed without
adequate provisions having been made to pay the claims of depositors, acting as
the receiver of state banks placed in receivership when appointed receiver by
state authorities, and preventing the continuance or development of unsound and
unsafe banking practices. In addition, the FDIC is authorized to examine insured
banks which are not members of the Federal Reserve System, such as Gilmer County
Bank, to determine the condition of such banks for insurance purposes. The FDIC
is also authorized to approve mergers, consolidations and assumption of deposit
liability transactions between insured banks and non-insured banks or
institutions, and to prevent capital or surplus diminution in such transactions
where the resulting, continued, or assumed bank is an insured non-member state
bank. The FDIC closely examines non-member banks for compliance with certain
federal statutes such as the Community Reinvestment Act of 1977 (the "CRA") and
the Truth-in-Lending Act.

Dividends

         The Company is a legal entity separate and distinct from the Banks. The
principal source of cash flow for the Company are dividends from the Banks.
There are various statutory and regulatory limitations on the payment of
dividends by the Banks, as well as by the Company to its shareholders.

         The payment of dividends by the Company and the Banks may be affected
or limited by regulatory requirements and policies, such as the maintenance of
adequate capital. If, in the opinion of the applicable regulatory authority, a
bank under its jurisdiction is engaged in or is about to engage in an unsafe or
unsound practice (which could include the payment of dividends depending on the
institution's financial condition), such authority may require, after notice and
hearing, that such bank cease and desist from such practice. The FDIC issued a
policy statement that provides that insured banks should generally only pay
dividends out of current operating earnings. The Federal Reserve has issued a
policy statement to the same effect for bank holding companies. In addition, all
insured depository institutions are subject to the capital-based limitations
required by FDICIA. See "--Capital Adequacy--FDICIA."

         Gilmer County Bank. Under Georgia law, Gilmer County Bank must obtain
approval of the DBF before it may pay cash dividends out of retained earnings if
(1) the total classified assets at the most recent examination of such bank
exceed 80% of the equity capital, (2) the aggregate amount of dividends declared
or anticipated to be declared in the calendar year exceeds 50% of the net
profits, after taxes but before dividends, for the previous calendar year, or
(3)



                                       7
<PAGE>   10

the ratio of equity capital to adjusted assets is less than 6%. As discussed
below, additional capital requirements imposed by the DBF may limit the Banks'
ability to pay dividends to the Company. See "--Capital Adequacy."

         First National. As a national bank, First National may not pay
dividends from its paid-in-capital. All dividends must be paid out of undivided
profits then on hand, after deducting expenses, including reserves for losses
and bad debts. In addition, a national bank is prohibited from declaring a
dividend on its shares of common stock until its surplus equals its stated
capital, unless there has been transferred to surplus no less than one-tenth of
the bank's net profits of the preceding two consecutive half-year periods (in
the case of an annual dividend). The approval of the OCC is required if the
total of all dividends declared by a national bank in any calendar year exceeds
the total of its net profits for that year combined with its retained net
profits for the preceding two years, less any required transfers to surplus.

         First National is also subject to the provisions of Section 23A of the
Federal Reserve Act, which place limits on the amount of loans or extensions of
credit to, or investments in, or certain other transactions with, affiliates and
on the amount of advances to third parties collateralized by the securities or
obligations of affiliates. In addition, most of these loans and certain other
transactions must be secured in prescribed amounts. First National is also
subject to the provisions of Section 23B of the Federal Reserve Act that, among
other things, prohibit an institution from engaging in certain transactions with
certain affiliates unless the transactions are on terms substantially the same,
or at least as favorable to such institution or its subsidiaries, as those
prevailing at the time for comparable transactions with non-affiliated
companies. First National is subject to certain restrictions on extensions of
credit to executive officers, directors, certain principal stockholders and
their related interests. Such extensions of credit (i) must be made on
substantially the same terms, including interest rates and collateral, as those
prevailing at the time for comparable transactions with third parties and (ii)
must not involve more than the normal risk of repayment or present other
unfavorable features.

Capital Adequacy

         Federal bank regulatory authorities have adopted risk-based capital
guidelines for banks and bank holding companies that are designed to make
regulatory capital requirements more sensitive to differences in risk profile
among banks and bank holding companies, account for off-balance sheet exposure,
and minimize disincentives for holding liquid assets. The resulting capital
ratios represent qualifying capital as a percentage of total risk-weighted
assets and off-balance sheet items. The guidelines are minimums, and the federal
regulators have noted that banks and bank holding companies contemplating
significant expansion programs should not allow expansion to diminish their
capital ratios and should maintain ratios well in excess of the minimums.

         FDICIA established a capital-based regulatory plan designed to promote
early intervention for troubled banks and requires the FDIC to choose the least
expensive resolution of bank failures. The capital-based regulatory framework
contains five categories of compliance with regulatory capital requirements,
including "well capitalized," "adequately capitalized," "undercapitalized,"
"significantly undercapitalized" and "critically undercapitalized." To qualify
as a "well capitalized" institution, a bank must have a leverage ratio of no
less than 5%, a Tier 1 risk-based ratio of no less than 6%, and a total
risk-based capital ratio of no less than 10%, and the bank must not be under any
order or directive from the appropriate regulatory agency to meet and maintain a
specific capital level.

         The current guidelines require all bank holding companies and
federally-regulated banks to maintain a minimum risk-based total capital ratio
equal to 8%, of which at least 4% must be Tier 1 capital. Under the FDICIA
regulations, the applicable agency can treat an institution as if it were in the
next lower category if the agency determines (after notice and an opportunity
for hearing) that the institution is in an unsafe or unsound condition or is
engaging in an unsafe or unsound practice. The degree of regulatory scrutiny of
a financial institution will increase, and the permissible activities of the
institution will decrease, as it moves downward through the capital categories.
Institutions that fall into one of the three undercapitalized categories may be
required to (i) submit a capital restoration plan; (ii) raise additional
capital; (iii) restrict their growth, deposit interest rates, and other
activities; (iv) improve their management; (v) eliminate management fees; or
(vi) divest themselves of all or a part of their operations. Bank holding
companies controlling financial institutions can be called upon to boost the
institutions' capital and to partially guarantee the institutions' performance
under their capital restoration plans. Tier 1 capital 


                                       8
<PAGE>   11

includes stockholders' equity, qualifying perpetual preferred stock and minority
interests in equity accounts of consolidated subsidiaries, but excludes goodwill
and most other intangible assets and excludes the allowance for loan and lease
losses. Tier 2 capital includes the excess of any preferred stock not included
in Tier 1 capital, mandatory convertible securities, hybrid capital instruments,
subordinated debt and intermediate-term preferred stock and general reserves for
loan and lease losses up to 1.25% of risk-weighted assets.

         Under these guidelines, banks' and bank holding companies' assets are
given risk-weights of 0%, 20%, 50% or 100%. In addition, certain off-balance
sheet items are given credit conversion factors to convert them to asset
equivalent amounts to which an appropriate risk-weight will apply. These
computations result in the total risk-weighted assets. Most loans are assigned
to the 100% risk category, except for first mortgage loans fully secured by
residential property and, under certain circumstances, residential construction
loans, both of which carry a 50% rating. Most investment securities are assigned
to the 20% category, except for municipal or state revenue bonds, which have a
50% rating, and direct obligations of or obligations guaranteed by the United
States Treasury or United States Government agencies, which have a 0% rating.

         Failure to meet capital guidelines could subject a bank to a variety of
enforcement remedies, including the termination of deposit insurance by the
FDIC, and to certain restrictions on its business. See "--FDICIA."

         The Federal Reserve has also implemented a leverage ratio, which is
Tier 1 capital as a percentage of average total assets less intangible assets,
to be used as a supplement to the risk-based guidelines. The principal objective
of the leverage ratio is to place a constraint on the maximum degree to which a
bank holding company may leverage its equity capital base. The Federal Reserve
has established a minimum 3% leverage ratio of Tier 1 capital to total assets
for the most highly rated bank holding companies and insured banks,
respectively. All other bank holding companies and insured banks will be
required to maintain a leverage ratio of 3% plus an additional cushion of at
least 100 to 200 basis points. The guidelines also provide that banking
organizations experiencing internal growth or making acquisitions will be
expected to maintain strong capital positions substantially above the minimum
supervisory levels, without significant reliance on intangible assets.
Furthermore, the guidelines indicate that the regulatory agencies will continue
to consider a tangible Tier 1 leverage ratio and other indicia of capital
strength in evaluating proposals for expansion or new activities. The tangible
Tier 1 leverage ratio is the ratio of a banking organization's Tier 1 capital,
less all intangibles, to total assets, less all intangibles. See "Management's
Discussion and Analysis of Financial Condition and Results of
Operations--Capital Resources."

         Federal banking agencies recently adopted final regulations mandating
that regulators take into consideration concentrations of interest rate and
credit risk and risks from nontraditional activities, as well as the
institution's ability to manage such risks, when determining the adequacy of an
institution's capital position. Under these rules, regulators must explicitly
include an institution's exposure to declines in the economic value of its
capital due to interest rates in evaluating an institution's capital adequacy.
The final rules do not codify a framework for assessing an institution's
exposure to interest rate risk; rather, such exposure would be considered as one
quantitative factor used in evaluating capital adequacy. Other quantitative
factors would include the institution's historical financial performance and its
earnings exposure to interest rate movements. Examiners will also consider
certain qualitative factors, including the institution's internal interest rate
risk management.

         DBF Capital Requirements. Notwithstanding the uniform risk-based
capital guidelines and leverage ratios discussed above, regulatory authorities
have the discretion to set individual minimum capital requirements for the
specific institutions at rates significantly exceeding the above minimum
guidelines and ratios. In addition to the capital standards imposed by federal
banking regulators, the DBF imposed an 8% primary capital ratio as a condition
to the approval of Gilmer County Bank's charter. This standard, which exceeds
the FDIC capital standards, is calculated as the ratio of total equity to total
assets, each as adjusted for unrealized gains and losses on securities and
allowance for loan losses. This heightened requirement was imposed during the
first three years of Gilmer County Bank's operation, after which time Gilmer
County Bank became subject to a 6% primary capital ratio. See "Management's
Discussion and Analysis of Financial Condition and Results of
Operations--Capital Resources."

         FDICIA. FDICIA was enacted on December 19, 1991 in large measure to
improve the supervision and examination of insured depository institutions in an
effort to reduce the number of bank failures and the resulting 

                                       9

<PAGE>   12

demands on the deposit insurance system. Among other matters, the FDICIA
requires that all depository institutions with assets in excess of $150 million,
or such larger threshold as may be established by the FDIC (currently $500
million), prepare and submit to the FDIC and appropriate federal and state
banking regulators annual financial statements that have been audited by
independent public accountants, file reports prepared by the depository
institutions containing a statement by management of its responsibilities and by
the depository institutions' independent public accountant attesting to the
accuracy of management's annual assessment of its financial reporting, internal
controls and regulatory compliance, and establish an audit committee composed of
members of the board of directors who are independent of management. The FDIC
has provided by regulation that these provisions of the FDICIA do not apply to
depository institutions with assets less than $500 million. An enactment of the
FDICIA has also resulted in the promulgation of regulations by regulatory
agencies which will tend to restrict to some degree the real estate lending
practices of financial institutions. The FDICIA otherwise provides for
additional supervision and regulation of financial institutions.

         Under the FDICIA, regulators must take prompt corrective action against
depository institutions that do not meet minimum capital requirements. FDICIA
and the regulations thereunder establish five capital categories as shown in the
following table:

<TABLE>
<CAPTION>
                                                 Total Risk-           Tier 1 Risk-            Tier 1
       Classification                           Based Capital          Based Capital          Leverage
       --------------                           -------------          -------------          --------
<S>                                             <C>                    <C>                    <C>

Well Capitalized (1)                                 10%                    6%                    5%
Adequately Capitalized (1)                            8%                    4%                    4%(2)
Undercapitalized (3)                                 <8%                   <4%                   <4%
Significantly Undercapitalized                       <6%                   <3%                   <3%
Critically Undercapitalized                           -                     -                    <2%

</TABLE>
---------------------

(1)      An institution must meet all three minimums.
(2)      3% for composite 1-rated institutions, subject to appropriate federal
         banking agency guidelines.
(3)      An institution is classified as "undercapitalized" if it is below the
         specified capital level for any of the three capital measures.

         A depository institution may be deemed to be in a capitalization
category that is lower than is indicated by its actual capital position if it
receives a less than satisfactory examination rating in any one of four
categories. As a depository institution moves downward through the
capitalization categories, the degree of regulatory scrutiny will increase and
the permitted activities of the institution will decrease. Action may be taken
by a depository institution's primary federal regulator against an institution
that falls into one of the three "undercapitalized" categories, including the
requirement of filing a capital plan with the institution's primary federal
regulator, prohibition on the payment of dividends and management fees,
restrictions on executive compensation, and increased supervisory monitoring.
Other restrictions may be imposed on the institution either by its primary
federal regulator or by the FDIC, including requirements to raise additional
capital, to sell assets, or to sell the institution.

         The foregoing capital guidelines may have an effect on the Company in a
variety of ways. Rapid growth, poor loan portfolio performance or poor earnings
performance, or a combination of these factors, could change the Company's
capital position in a short period of time, making an additional capital
infusion necessary. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations--Capital Resources."

Safety and Soundness

         FDICIA imposes certain restrictions on transactions and required
federal banking agencies to prescribe overall safety and soundness standards
relating to internal controls, loan underwriting and documentation and asset
growth. If an insured depository institution or its holding company fails to
meet any of the regulatory standards promulgated by the regulation, then such
institution or company must submit a plan within 30 days to the FDIC describing
the steps it will take to correct the deficiency. If an institution or company
fails to submit a plan or 


                                       10
<PAGE>   13

implement the plan within the time period allowed by the agency, the FDIC must
order the institution or company to correct the deficiency and may take such
additional steps as restricting asset growth, requiring an increase in the
institution's ratio of tangible equity to assets, restricting rates of interest
that the institution may pay or take any further corrective action the agency
deems necessary.

Federal Deposit Insurance Premiums and Assessments

         The deposits of the Banks are currently insured to a maximum of
$100,000 per depositor, subject to certain aggregation rules. The FDIC
establishes rates for the payment of premiums by federally insured banks and
thrifts for deposit insurance. Separate insurance funds, the Bank Insurance Fund
("BIF") and the Savings Association Insurance Fund ("SAIF"), are maintained for
commercial banks and thrifts, with insurance premiums from the banking industry
used to offset losses from insurance payouts when banks and thrifts fail. Since
1993, insured depository institutions like the Banks have paid for deposit
insurance under a risk-based premium system. Under this system, until mid-1995
depository institutions paid to the BIF or the SAIF from $0.23 to $0.31 per $100
of insured deposits depending on their capital levels and risk profile, as
determined by their primary federal regulator on a semi-annual basis.

         Once the designated ratio for the BIF was reached in May 1995, the FDIC
was authorized to reduce the minimum assessment rate below the 23 basis points
and to set future assessment rates at such levels that would maintain the fund's
reserve ratio at the designated level. In August 1995, the FDIC adopted
regulations reducing the assessment rates for BIF-member banks. Subsequently, on
November 14, 1995, the FDIC announced that, beginning in 1997, it would further
reduce the deposit insurance premiums for 92% of all BIF members that are in the
highest capital and supervisory categories to $2,000 per year, regardless of
deposit size. At the same time, the FDIC elected to retain the existing
assessment rate range for SAIF members for the foreseeable future given the
undercapitalized nature of that insurance fund. Thrift industry representatives
argued that this significant premium disparity resulted in savings associations
having to operate at a competitive disadvantage to their BIF insured bank
counterparts.

         On September 30, 1996, the President signed the Deposit Insurance Fund
Act of 1996 ("DIFA"). DIFA mandated that the FDIC impose a one-time special
assessment on the SAIF-assessable deposits of each insured depository
institution at a rate applicable to all such institutions that the FDIC
determined would cause the SAIF to achieve its designated reserve ratio of 1.25%
as of October 1, 1996. The assessment was based on the amount of SAIF-insured
deposits owned by each institution as of March 31, 1995. DIFA provides that the
FDIC may not set semi-annual assessments with respect to SAIF or BIF in excess
of the amount needed to maintain the 1.25% designated reserve ratio or, if the
reserve ratio is less than the designated reserve ratio, to increase the reserve
ratio to the designated reserve ratio. On October 10, 1996, the FDIC adopted a
final rule governing the payment of the SAIF special assessment to recapitalize
the fund in the amount of 65.7 basis points for SAIF members.

         In addition, DIFA mandates the merger of the SAIF and BIF, effective
January 1, 1999, but only if no insured depository institution is a savings
association on that date. The combined deposit insurance fund would be called
the "deposit insurance fund" or "DIF."

         Under the FDIA, insurance of deposits may be terminated by the FDIC
upon a finding that the institution has engaged in unsafe and unsound practices,
is in an unsafe or unsound condition to continue operations, or has violated any
applicable law, regulation, rule, order, or condition imposed by the FDIC.

Regulatory and Legislative Changes

         Georgia Interstate Banking Act. The Company and the Banks are also
subject to other state and federal governmental regulations. On March 16, 1994,
the Georgia General Assembly adopted the Georgia Interstate Banking Act (the
"Georgia Act"). The Georgia Act revised the existing regional interstate banking
law to expand the scope nationwide. The Georgia Act, as amended by the 1996
Georgia Interstate Banking Act, permits bank holding companies located in any
state outside of Georgia to acquire Georgia banks, or to acquire bank holding
companies owning Georgia banks. However, the Georgia Act retains the existing
prohibition, subject to certain limitations, on 


                                       11
<PAGE>   14

acquiring banks in operation less than five years. Further, the board of
directors of a Georgia bank or bank holding company may adopt a resolution to
exempt its bank or bank holding company from acquisition under the Georgia Act.
Finally, any future acquisition of Gilmer County Bank must receive prior
approval from the Federal Reserve and the DBF.

         Georgia Intrastate Banking Act. The Georgia General Assembly recently
enacted legislation (the "Georgia Intrastate Banking Act") altering the public
policy of the State regarding intrastate branch banking. Essentially, the
legislation allows a bank to establish de novo branch banks on a limited basis
beginning July 1, 1996. Between July 1, 1996 and June 30, 1998, any Georgia bank
or group of affiliated banks under a single holding company were permitted,
subject to certain restrictions, to establish new or additional branch banks in
any three counties in the State of Georgia in which the bank or group of banks
were not currently operating. Effective July 1, 1998, the restrictions on the
number of de novo branch banks which could be established lapsed.

         Several federal statutes impact the ways in which the Banks conduct
business, include FDICIA, the Riegle Community Development and Regulatory
Improvement Act of 1994 ("RCDRIA"), and the Interstate Banking Act.

         RCDRIA. RCDRIA was enacted September 23, 1994, to promote economic
revitalization and community development to "investment areas." RCDRIA
establishes a Community Development Financial Institutions Fund to achieve these
objectives. The fund is authorized to provide financial assistance through a
variety of mechanisms, including equity investments, grants, loans, credit union
shares and deposits. The amount of assistance any community development
financial institution and its subsidiaries and affiliates may receive is
generally limited to $5 million. A qualifying institution may receive an
additional $3.75 million for the purpose of serving an investment area in
another state.

         RCDRIA provides certain regulatory relief, requiring each federal
agency to streamline and modify its regulations and policies, remove
inconsistencies and eliminate outmoded and duplicative requirements. RCDRIA
directs the federal agencies to coordinate examinations among affiliate banks,
coordinate examinations with other federal banking agencies, and work to
coordinate with state banking agencies. The federal banking agencies are also
directed to work jointly in developing a system for banks and savings
associations to file reports and statements electronically and to adopt a single
form for filing core information in reports and statements.

         Interstate Banking Act. The Interstate Banking Act, enacted September
29, 1994, permits, among other things, bank holding companies to merge their
multi-state bank subsidiaries into a single bank by June 1, 1997 (unless state
legislators act to "opt-out" of this provision), to acquire banks in any state
one year after the effective date of the Interstate Banking Act, and to
establish de novo branches across state lines if the individual states into
which a potential de novo entrant proposes to branch specifically pass
legislation to "opt-in."

         Under the Interstate Banking Act, a bank could merge, beginning on June
1, 1997, with a bank in another state if the transaction did not involve a bank
in a home state which had enacted a law after the date of enactment of the
Interstate Banking Act and before June 1, 1997 that applied equally to all out
of state banks and expressly prohibited such interstate merger transactions.
Such a law would have no effect on merger transactions approved before the
effective date of such state law. States were also allowed to permit merger
transactions before June 1, 1997. Georgia elected to allow such mergers
beginning June 1, 1997. The Interstate Banking Act authorizes interstate mergers
involving the acquisition of a branch of a bank without the acquisition of the
bank only as state law permits an out of state bank to acquire a branch without
acquiring the bank; Georgia has not authorized such transactions. State minimum
age laws for banks to be acquired will be preserved unless state law provides
for a minimum age period of more than five years. After consummation of any
interstate merger transaction, a resulting bank may establish or operate
additional branches at any location where any bank involved in the transaction
could have established or operated a branch under applicable federal or state
law.

         Beginning September 29, 1995, the Board of Governors of the Federal
Reserve System was authorized to approve the acquisition by a well capitalized
and adequately managed bank holding company of a bank that is located in another
state without regard to whether the acquisition is prohibited under the laws of
any state. Again, state minimum age laws for banks to be acquired will be
preserved unless the state law provides for a minimum age period 



                                       12
<PAGE>   15

of more than five years. The Federal Reserve may not approve an interstate
acquisition which would result in the acquirer's controlling more than 10% of
the total amount of deposits of insured depository institutions in the United
States with 30% or more of the deposits in the home state of the target bank. A
state may waive the 30% limit based on criteria that does not discriminate
against out of state institutions. The limitations do not apply to the initial
entry into a state by a bank holding company unless the state has a deposit
concentration cap that applies on a nondiscriminatory basis to in state or out
of state bank holding companies making an initial acquisition. Notwithstanding
the foregoing, anti-trust laws are not affected by the Interstate Banking Act.

         The Interstate Banking Act now provides that banks may establish
branches across state lines upon approval of the appropriate federal regulator
if the state "opts-in" by enacting legislation that expressly permits de novo
interstate branching. The establishment of the initial branch in a host state
which permits de novo interstate branching is subject to the same requirements
which apply to the initial acquisition of a bank in a host state, other than the
deposit concentration limits, since the bank would not control any deposits in
the host state at the time of entry. Once a branch has been established by de
novo branching, the bank may establish and acquire additional branches at any
location in the host state in the same manner as any bank in the host state
could have established or acquired additional branches under applicable federal
or state law.

         Other Regulatory Initiatives. On April 19, 1995, the four federal bank
regulatory agencies adopted revisions to the regulations promulgated pursuant to
the CRA which are intended to set distinct assessment standards for financial
institutions. The revised regulations contain three evaluation tests: (i) a
lending test which will compare the institution's market share of loans in low
and moderate income areas to its market share of loans in its entire service
area and the percentage of a bank's outstanding loans to low and moderate income
areas or individuals, (ii) a services test which will evaluate the provisions of
services that promote the availability of credit to low and moderate income
areas, and (iii) an investment test, which will evaluate an institution's record
of investments in organizations designed to foster community development, small
and minority-owned businesses and affordable housing lending, including state
and local government housing or revenue bonds. The regulations are designed to
reduce some paperwork requirements of the current regulations and provide
regulators, institutions and community groups with a more objective and
predictable manner with which to evaluate the CRA performance of financial
institutions. The rule became effective on January 1, 1996, at which time
evaluation under streamlined procedures began for institutions with assets of
less than $250 million that are owned by a holding company with total assets of
less than $1 billion. Gilmer County Bank was examined for CRA compliance in May
1996 and received a CRA rating of 1. Prior to the Conversion, First National was
examined for CRA compliance in April 1996 and received a rating of
"satisfactory".

         Congress and various federal agencies (including, in addition to the
bank regulatory agencies, the Housing and Urban Development Agency, the Federal
Trade Commission and the Department of Justice) (collectively the "Federal
Agencies") responsible for implementing the nation's fair lending laws have been
increasingly concerned that prospective home buyers and other borrowers are
experiencing discrimination in their efforts to obtain loans. In recent years,
the Department of Justice has filed suit against financial institutions, which
it determined had discriminated, seeking fines and restitution for borrowers who
allegedly suffered from discriminatory practices. Most, if not all, of these
suits have been settled (some for substantial sums) without a full adjudication
on the merits.

         On March 8, 1994, the Federal Agencies, in an effort to clarify what
constitutes lending discrimination and specify the factors the agencies will
consider in determining if lending discrimination exists, announced a joint
policy statement detailing specific discriminatory practices prohibited under
the Equal Credit Opportunity Act and the Fair Housing Act. In the policy
statement, three methods of proving lending discrimination were identified: (1)
overt evidence of discrimination, when a lender blatantly discriminates on a
prohibited basis, (2) evidence of disparate treatment, when a lender treats
applicants differently based on a prohibited factor even where this is no
showing that the treatment was motivated by prejudice or a conscious intention
to discriminate against a person, and (3) evidence of disparate impact, when a
lender applies a practice uniformly to all applicants, but the practice has a
discriminatory effect, where such practices are neutral on their face and are
applied equally, unless the practice can be justified on the basis of business
necessity.



                                       13
<PAGE>   16

         On July 3, 1997, President Clinton signed legislation to clarify that
branches of state-chartered banks operating in host states are covered by the
laws of their home chartering state. The Riegle-Neal Amendment Act of 1997 is
intended to preserve the dual banking system by subjecting state banks only to
the rules of their chartering states.

         Other legislative and regulatory proposals regarding changes in banking
and the regulation of banks, thrifts and other financial institutions and bank
and bank holding company powers are being considered by the executive branch of
the Federal government, Congress and various state governments, including
Georgia. Among other items under consideration are the possible combination of
the BIF and SAIF, changes in or repeal of the Glass-Steagall Act which separates
commercial banking from investment banking, and changes in the BHCA to broaden
the powers of "financial services" companies to own and control depository
institutions and engage in activities not closely related to banking. Certain of
these proposals, if adopted, could significantly change the regulation of banks
and the financial services industry. It cannot be predicted whether any of these
proposals will be adopted, and, if adopted, how these proposals will affect the
Company and the Bank.


                        SELECTED STATISTICAL INFORMATION

         The following tables set forth certain statistical information and
should be read in conjunction with Management's Discussion and Analysis of
Financial Condition and Results of Operations contained in this Report and the
Company's consolidated financial statements and notes thereto beginning at page
F-1 of this Report. The average statistical data presented in this report are
generally based on daily average balances.


                  (Remainder of Page Intentionally Left Blank)





                                       14
<PAGE>   17



Distribution of Assets, Liabilities and Shareholders' Equity; Interest Rates and
Interest Differential

         The table below shows, for the periods indicated, the daily average
balances outstanding for the major categories of interest-bearing assets and
interest-bearing liabilities, and the average interest rate earned or paid
thereon. Such yields are calculated by dividing income or expense by the average
balance of the corresponding assets or liabilities.

<TABLE>
<CAPTION>
                                Average Balances, Interest Income/Expense and Yields/Rates
                                                 Taxable Equivalent Basis

                                                   Year Ended December 31, 1998            Year Ended December 31, 1997
                                              -------------------------------------     -----------------------------------
                                               Average       Income/         Yield/     Average       Income/        Yield/
                                               Balance       Expense          Rate      Balance       Expense         Rate
                                               -------       -------          ----      -------       -------        -----
                                                                  (amounts in thousands, except percentages)
Assets

Earning assets:
<S>                                           <C>            <C>             <C>       <C>            <C>            <C>   
  Loans, net of unearned income (1) ....      $  95,353       $ 9,645         10.12%   $  74,753       $7,675         10.27%
  Securities:
     Taxable ...........................         15,919         1,009          6.34       17,498        1,160          6.63
     Tax-exempt ........................          7,943           570          7.18        3,257          258          7.92
                                              ---------       -------                  ---------       ------              
  Total securities .....................         23,862         1,579          6.62       20,755        1,418          6.83
  Federal funds sold ...................          4,448           271          6.09        2,895          160          5.53
                                              ---------       -------                  ---------       ------              
     Total interest-earning assets .....        123,663        11,495          9.30       98,403        9,253          9.40

Non interest-earning assets:
  Cash and due from banks ..............          3,587                                    2,170                      
  Premises and equipment ...............          2,419                                    1,644                      
  Accrued interest and other assets ....          2,551                                    1,818                      
  Allowance for loan losses ............         (1,141)                                    (774)                     
                                              ---------                                ---------                        
Total assets ...........................      $ 131,079                                $ 103,261                      
                                              =========                                =========                      

Liabilities and Shareholders' Equity

Interest-bearing liabilities:
  Demand deposits ......................      $  30,238         1,444          4.78    $  22,681        1,116          4.92
  Savings deposits .....................         24,463         1,210          4.95       17,984          933          5.19
  Time deposits ........................         52,104         3,237          6.21       45,616        2,862          6.27
                                              ---------       -------                  ---------       ------              
                                                106,805         5,891          5.47       86,281        4,911          5.69
Other short-term borrowings ............          4,106           178          4.34        4,471          201          4.50
Long-term debt .........................          6,649           428          6.44        2,090          150          7.18
                                              ---------       -------                  ---------       ------              
     Total interest-bearing liabilities         117,560         6,497          5.54       92,842        5,262          5.67
                                              ---------       -------                  ---------       ------              

Noninterest-bearing liabilities:
  Demand deposits ......................          3,940                                    3,527                      
  Accrued interest and other liabilities            654                                      500                      
  Shareholders' equity .................          8,925                                    6,392                      
                                              ---------                                ---------                      
Total  liabilities and shareholders'                       
   equity .............................       $ 131,079                                $ 103,261
                                              =========                                =========                      

Net interest income/net interest
   spread ..............................                        4,998          3.76%                    3,991          3.73%
                                                                               ====                                    ==== 

Net yield on earning assets ............                                       4.04%                                   4.06%
                                                                               ====                                    ==== 
Taxable equivalent adjustment:
   Loans ...............................                           31                                      22         
   Investment securities ...............                          194                                      88         
                                                              -------                                  ------         
     Total taxable equivalent
       adjustment ......................                          225                                     110         
                                                              -------                                  ------         

Net interest income ....................                      $ 4,773                                  $3,881         
                                                              =======                                  ======         
</TABLE>

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

(1)      Average loans include nonaccrual loans. All loans and deposits are
         domestic.




                                       15
<PAGE>   18


         The following tables set forth, for the years ended December 31, 1998,
1997, and 1996 a summary of the changes in interest income and interest expense
resulting from changes in interest rates and in changes in the volume of earning
assets and interest-bearing liabilities, segregated by category. The change due
to volume is calculated by multiplying the change in volume by the prior year's
rate. The change due to rate is calculated by multiplying the change in rate by
the prior year's volume. The change attributable to both volume and rate is
calculated by multiplying the change in volume by the change in rate. Figures
are presented on a taxable equivalent basis.



                          Rate/Volume Variance Analysis

<TABLE>
<CAPTION>
                                                        Change                         Interest                  Variance (1)
                                     Average Volume    in Volume   Average Rate     Income/Expense  Variance   Attributed to 1998
                                     --------------    ---------   ------------     --------------  --------   ------------------
                                      1998     1997     1998-97    1998    1997      1998    1997    1998-97    Volume     Rate
                                      ----     ----     -------    ----    ----      ----    ----    -------    ------     ----
                                                                (amounts in thousands, except percentages)
<S>                                <C>        <C>       <C>        <C>     <C>      <C>      <C>     <C>       <C>       <C>   
Earning assets: 
Loans, net of unearned
  income ....................      $ 95,353   $74,753   $ 20,600   10.12%  10.27%   $ 9,645  $7,675  $ 1,970   $ 2,084   $(114)
                                   --------   -------   --------                    -------  ------  -------   -------   ----- 
Investment securities:
  Taxable ...................        15,919    17,498     (1,579)   6.34    6.63      1,009   1,160     (151)     (102)    (49)
  Tax Exempt ................         7,943     3,257      4,686    7.18    7.92        570     258      312       338     (26)
                                   --------   -------   --------                    -------  ------  -------   -------   ----- 
    Total investment
     securities .............        23,862    20,755      3,107    6.62    6.83      1,579   1,418      161       236     (75)
                                   --------   -------   --------                    -------  ------  -------   -------   ----- 
Federal funds sold ..........         4,448     2,895      1,553    6.09    5.53        271     160      111        93       8
                                   --------   -------   --------                    -------  ------  -------   -------   ----- 

    Total earning assets ....      $123,663   $98,403   $ 25,260    9.30    9.40     11,495   9,253    2,242     2,413    (171)
                                   ========   =======   ========                                                               

Interest-bearing liabilities:
Deposits:
  Demand ....................      $ 30,238   $22,681   $  7,557    4.78    4.92      1,444   1,116      328       361     (33)
  Savings ...................        24,463    17,984      6,479    4.95    5.19      1,210     933      277       322     (45)
  Time ......................        52,104    45,616      6,488    6.21    6.27      3,237   2,862      375       403     (28)
                                   --------   -------   --------                    -------  ------  -------   -------   ----- 
    Total interest-bearing
     deposits ...............       106,805    86,281     20,524    5.52    5.69      5,891   4,911      980     1,086    (106)

Other short-term borrowings .         4,106     4,471       (365)   4.34    4.50        178     201      (23)      (16)    (17)
Long-term debt ..............         6,649     2,090      4,559    6.44    7.18        428     150      278       295      (7)
                                   --------   -------   --------                    -------  ------  -------   -------   ----- 

    Total interest-bearing
     liabilities ............      $117,560   $92,842   $ 24,718    5.53    5.67      6,497   5,262    1,235     1,365    (130)
                                   ========   =======   ========                    -------  ------  -------   -------   -----

Net interest income/net
  interest spread ...........                                       3.77%   3.73%   $ 4,998  $3,991  $ 1,007   $ 1,048   $ (41)
                                                                   =====   =====    =======  ======  =======   =======   ===== 

Net yield on earning assets .                                       4.04%   4.06%                                             
                                                                   =====   =====                                              

Net cost of funds ...........                                       5.26%   5.34%                                             
                                                                   =====   =====                                              
</TABLE>

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

(1)  The change in interest due to both rate and volume has been allocated to
     volume and rate changes in proportion to the relationship of the absolute
     dollar amounts of the change in each.

                                       16
<PAGE>   19

<TABLE>
<CAPTION>
                                                        Change                       Interest                   Variance (1)
                                     Average Volume   in Volume   Average Rate    Income/Expense   Variance  Attributed to 1997
                                   -----------------  ---------   -------------   ---------------  --------  ------------------
                                     1997      1996    1997-96    1997     1996    1997     1996    1997-96   Volume      Rate
                                                              (amounts in thousands, except percentages)
<S>                                <C>       <C>      <C>         <C>     <C>     <C>      <C>     <C>        <C>        <C>  
Earning assets:
Loans, net of unearned
  income ....................      $74,753   $51,008   $ 23,745   10.27%  10.23%  $7,675   $5,219  $ 2,456    $ 2,436    $  20
                                   -------   -------   --------                   ------   ------  -------    -------    -----
Investment securities:
  Taxable ...................       17,498    15,277      2,221    6.63    6.41    1,160      979      181        146       35
  Tax Exempt ................        3,257       445      2,812    7.92    8.09      258       36      222        223       (1)
                                   -------   -------   --------                   ------   ------  -------    -------    -----
    Total investment
     securities .............       20,755    15,722      5,033    6.83    6.45    1,418    1,015      403        369       34
                                   -------   -------   --------                   ------   ------  -------    -------    -----
Federal funds sold ..........        2,895     2,025        870    5.53    5.14      160      104       56         48        8
                                   -------   -------   --------                   ------   ------  -------    -------    -----

    Total earning assets ....      $98,403   $68,755   $ 29,648    9.40    9.22    9,253    6,338    2,915      2,842       73
                                   =======   =======   ========                                                               

Interest-bearing liabilities:
Deposits:
  Demand ....................      $22,681   $14,849   $  7,832    4.92    4.96    1,116      737      379        385       (6)
  Savings ...................       17,984    10,829      7,155    5.19    5.28      933      572      361        371      (10)
  Time ......................       45,616    33,365     12,251    6.27    6.37    2,862    2,127      735        768      (33)
                                   -------   -------   --------                   ------   ------  -------    -------    -----
    Total interest-bearing
     deposits ...............       86,281    59,043     27,238    5.69    5.82    4,911    3,436    1,475      1,524      (49)

Other short-term borrowings .        4,471     4,777       (306)   4.50    4.58      201      219      (18)       (14)      (4)
Long-term debt ..............        2,090        62      2,028    7.18    8.06      150        5      145        146       (1)
                                   -------   -------   --------                   ------   ------  -------    -------    -----

    Total interest-bearing
     liabilities ............      $92,842   $63,882   $ 28,960    5.67    5.73    5,262    3,660    1,602      1,656      (54)
                                   =======   =======   ========                   ------   ------  -------    -------    -----

Net interest income/net
  interest spread ...........                                      3.73%   3.49%  $3,991   $2,678  $ 1,313    $ 1,186    $ 127
                                                                  =====   =====   ======   ======  =======    =======    =====

Net yield on earning assets .                                      4.06%   3.90%                                              
                                                                  =====   =====                                               
Net cost of funds ...........                                      5.34%   5.32%                                              
                                                                  =====   =====                                               
</TABLE>
-------------
(1)      The change in interest due to both rate and volume has been allocated
         to volume and rate changes in proportion to the relationship of the
         absolute dollar amounts of the change in each.


                  (Remainder of Page Intentionally Left Blank)




                                       17
<PAGE>   20

Securities Portfolio

         The carrying amount of securities at the end of each of the years
presented is set forth in the following table:

                              Securities Portfolio

<TABLE>
<CAPTION>
                                                        December 31,
                                                   --------------------
                                                     1998         1997
                                                   -------      -------
Securities Available-for-Sale:                    (amounts in thousands)
<S>                                                <C>          <C>    
   U.S. Treasury and U.S. Government agencies      $13,642      $13,980
   Mortgage-backed securities ...............        1,908        1,165
   State and municipal securities ...........        5,776          -0-
   Equity securities ........................          614          400
                                                   -------      -------

     Total ..................................      $21,940      $15,545
                                                   =======      =======

Securities Held-to-Maturity:
   State and municipal securities ...........      $ 6,218      $ 4,181
                                                   =======      =======
</TABLE>

         Average taxable securities were 66.7 percent of the portfolio in 1998
compared to the prior year level of 84.3 percent. The increase of tax exempt
securities in 1998 reflects the Bank's intent to reduce the effect of federal
income taxation.

         The maturities and weighted average yields of the investments in the
1998 portfolio of securities are presented below. The average maturity of the
securities portfolio is 6.4 years with an average yield of 6.6 percent. Taxable
equivalent adjustments (using a 34 percent tax rate) have been made in
calculating yields on tax-exempt obligations. Equity securities have been
excluded since these instruments have no maturity date.

                      Security Portfolio Maturity Schedule

<TABLE>
<CAPTION>
                                                                         Maturing
                                  --------------------------------------------------------------------------------------
                                        Within              After One But        After Five But             After
                                       One Year           Within Five Years     Within Ten Years          Ten Years
                                       --------           -----------------     ----------------          ---------
                                  Amount       Yield      Amount      Yield    Amount        Yield    Amount       Yield
                                  ------       -----      ------      -----    ------        -----    ------       -----
                                                         (amounts in thousands, except percentages)
Securities Available-for-Sale:

    <S>                           <C>          <C>        <C>         <C>      <C>           <C>      <C>          <C>       
    U.S. Treasury ..........      $  502        6.14%      $  510      6.10%   $  -0-          -0-%   $  -0-          -0-%
    U.S. Government agencies       1,197        6.01        4,945      6.22     5,986         5.95       500         6.00 
    Mortgage-backed ........         -0-         -0-        1,908      6.98       -0-          -0-       -0-          -0- 
    State and municipal ....         103        5.87          104      6.84     3,395         6.54     2,176         7.12 
                                  ------        ----       ------      ----    ------         ----    ------         ----
                                  $1,802        6.04       $7,467      6.50    $9,381         6.16    $2,676         6.91 
                                  ======        ====       ======      ====    ======         ====    ======         ==== 
Securities Held-to-Maturity: 
                                                                                                                                 
    State and municipal ....      $  250        6.04%      $1,109      6.42%   $  669         7.90%   $4,190         7.83%
                                  ======        ====       ======      ====    ======         ====    ======         ==== 
</TABLE>
                                                          
         There were no securities held by the Bank of which the aggregate value
on December 31, 1998 exceeded ten percent of shareholders' equity at that date.
(Securities which are payable from and secured by the same source of revenue or
taxing authority are considered to be securities of a single issuer. Securities
of the U.S. Government and U.S. Government agencies and corporations are not
included.)



                                       18
<PAGE>   21

Loan Portfolio

         The following table shows the classification of loans by major category
at December 31, 1998 and 1997.

                                 Types of Loans

<TABLE>
<CAPTION>
                                                                            December 31,
                                                ---------------------------------------------------------------------
                                                              1998                                 1997
                                                ---------------------------------      ------------------------------
                                                                      Percent                             Percent
                                                   Amount            of Total            Amount           of Total
                                                   ------            --------            ------           --------
                                                             (amounts in thousands, except percentages)

<S>                                             <C>                  <C>               <C>                <C>  
Commercial, financial and agricultural.....     $     26,883            20.7%          $    16,536           19.5%
Real estate - construction.................            8,543             6.5%                5,119            6.1%
Real estate - other (1)....................           78,965            60.8%               50,928           60.2%
Consumer...................................           13,743            10.5%               10,835           12.8%
Other loans................................            1,697             1.5%                1,166            1.4%
                                                ------------           -----           -----------          ----- 
                                                     129,831           100.0%               84,584          100.0%
                                                                       =====                                ===== 

Less:
Allowance for loan losses..................            1,686                                   930
                                                ------------                           -----------

Net loans..................................     $    128,145                           $    83,654
                                                ============                           ===========

</TABLE>

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

(1)  The "real estate - other" category includes multi-family residential, home
     equity, commercial real estate and undeveloped agricultural real estate
     loans.


         The following table shows the maturity distribution of selected loan
classifications at December 31, 1998 and an analysis of these loans maturing in
over one year.

              Selected Loan Maturity and Interest Rate Sensitivity

<TABLE>
<CAPTION>
                                                                                 Rate Structure for Loans
                                                     Maturity                     Maturing Over One Year
                                 -------------------------------------------   ----------------------------
                                               Over One
                                   One           Year       Over               Predetermined    Floating or
                                 Year or       Through      Five                 Interest       Adjustable
                                   Less       Five Years   Years       Total       Rate            Rate
                                 --------     ----------   -----      -------  --------------  ------------
                                                         (amounts in thousands)
<S>                              <C>          <C>          <C>        <C>      <C>              <C>   
Commercial, financial
   and agricultural ........      $14,516      $12,099      $268      $26,883      $9,523        $2,844
Real estate - construction .        8,543          -0-       -0-        8,543         -0-           -0-
                                 --------     ----------   -----      -------  --------------  ------------
     Total .................      $23,059      $12,099      $268      $35,426      $9,523        $2,844
                                 ========     ==========   =====      =======  ==============  ============
</TABLE>



                                       19
<PAGE>   22

         The following table presents information concerning outstanding
balances of nonperforming assets at December 31, 1998 and 1997.

                              Nonperforming Assets

<TABLE>
<CAPTION>
                                                                        December 31,
                                                                 -------------------------
                                                                     1998          1997
                                                                 ---------      ----------

                                                           (amounts in thousands, except ratios)
<S>                                                              <C>            <C>       
Nonaccruing loans .................................              $       4        $   15    
Loans past due 90 days or more ....................                     23            13    
Restructured loans ................................                    -0-           -0-    
                                                                 ---------        ------    
Total nonperforming loans .........................                     27            28    
Nonaccruing securities ............................                    -0-           -0-    
Other real estate .................................                    -0-           -0-    
                                                                 ---------        ------    
                                                                                       
Total nonperforming assets ........................              $      27        $   28    
                                                                 =========        ======    
                                                                                       
Ratios:                                                                                
  Loan loss allowance to total nonperforming assets                  62.44         33.21  
                                                                 =========        ======    
  Total nonperforming loans to total loans                                             
     (net of unearned interest) ...................                 0.0002        0.0003 
                                                                 =========        ======    
  Total nonperforming assets to total assets ......                 0.0001        0.0002 
                                                                 =========        ======    
</TABLE>
                                                                
         It is the general policy of the Bank to stop accruing interest income
and place the recognition of interest on a cash basis when any commercial,
industrial or real estate loan is past due as to principal or interest and the
ultimate collection of either is in doubt. Accrual of interest income on
consumer installment loans is suspended when any payment of principal or
interest, or both, is more than ninety days delinquent. When a loan is placed on
a nonaccrual basis, any interest previously accrued but not collected is
reversed against current income unless the collateral for the loan is sufficient
to cover the accrued interest or a guarantor assures payment of interest.

         There has been no significant impact on the Company's financial
statements as a result of the provisions of Statement of Financial Accounting
Standards No. 114, Accounting by Creditors for Impairment of a Loan, or
Statement of Accounting Standards No. 118, Accounting by Creditors for
Impairment of a Loan--Income Recognition and Disclosures.

Summary of Loan Loss Experience

         The provision for loan losses, which is charged to operating results,
is based on the growth of the loan portfolio, the amount of net loan losses
incurred and management's estimation of potential future losses based on an
evaluation of the risk in the loan portfolio. Management believes that the
$1,686,395 in the allowance for loan losses at December 31, 1998 (1.2% of total
net outstanding loans at that date) was adequate to absorb known risks in the
portfolio based upon the Bank's historical experience. No assurance can be
given, however, that increased loan volume, adverse economic conditions or other
circumstances will not result in increased losses in the Bank's loan portfolio.



                                       20
<PAGE>   23

         The following table sets forth certain information with respect to the
Company's loans, net of unearned income, and the allowance for loan losses for
each of the last three fiscal years:

                        Analysis of Loan Loss Experience

<TABLE>
<CAPTION>
                                                              1998          1997          1996
                                                              ----          ----          ----
                                                          (amounts in thousands, except ratios)
<S>                                                        <C>            <C>           <C>    
Allowance for loan losses at beginning of year ......      $    930       $   655       $   325
Adjustment of business acquisition ..................           557           -0-           -0-
Loans charged off:
   Commercial, financial, and agricultural ..........            32            95           -0-
   Real estate-construction .........................           -0-            45           -0-
   Real estate - other ..............................           -0-             2             6
   Consumer .........................................           104            85            32
                                                           --------       -------       -------
     Total loans charged off ........................           136           227            38
                                                           --------       -------       -------
Recoveries on loans previously charged off:
   Commercial, financial, and agricultural ..........             6             2           -0-
   Real estate-construction .........................           -0-             8           -0-
   Real estate-other ................................           -0-             1           -0-
   Consumer .........................................            29            11           -0-
                                                           --------       -------       -------
     Total recoveries on loans previously charged off            35            22           -0-
                                                           --------       -------       -------

Net loans charged off ...............................           101           205            38
                                                           --------       -------       -------

Provisions for loan losses ..........................           300           480           368
                                                           --------       -------       -------

Allowance for loan losses at end of period ..........      $  1,686       $   930       $   655
                                                           ========       =======       =======

Loans, net of unearned income, at end of period .....      $129,831       $84,584       $64,962
                                                           ========       =======       =======

Average loans, net of unearned income, outstanding 
   for the period ...................................      $ 95,353       $74,753       $51,008
                                                           ========       =======       =======

Ratios:
Allowance at end of period to loans, net of
   unearned income ..................................          1.02%         1.10%         1.01%
Allowance at end of period to average loans,
   net of unearned income ...........................          1.70%         1.24%         1.28%
Net charge-offs to average loans, net of
   unearned income ..................................           .10%          .27%          .07%
Net charge-offs to allowance at end of period .......          5.90%        22.04%         5.80%
Recoveries to prior year charge-offs ................         15.40%        57.89%         -0-%
</TABLE>


         In assessing adequacy, management relies predominantly on its ongoing
review of the loan portfolio, which is undertaken both to ascertain whether
there are probable losses which must be charged off and to assess the risk
characteristics of the portfolio in the aggregate. This review takes into
consideration the judgments of the responsible lending officers and senior
management, and also those of bank regulatory agencies that review the loan
portfolio as part of the regular bank examination process. In evaluating the
allowance, management also considers the loan loss experience of the Bank, the
amount of past due and nonperforming loans, current and anticipated economic
conditions, lender requirements and other appropriate information.



                                       21
<PAGE>   24

         Management allocated the reserve for loan losses to specific loan
classes as follows:

                     Allocation of Allowance for Loan Losses

<TABLE>
<CAPTION>
                                                              December 31,
                                                 ---------------------------------------
                                                        1998                  1997
                                                 ------------------   ------------------
                                                           Percent              Percent
                                                 Amount    of Total   Amount    of Total
                                                 ------    --------   ------    --------
                                               (amounts in thousands, except percentages)
<S>                                              <C>       <C>        <C>       <C>
Domestic Loans (1)
     Commercial, financial and agricultural      $  421       25%      $186       20%
     Real estate - construction ...........         118        7         55        6
     Real estate - other ..................         894       53        567       61
     Consumer .............................         253       15        122       13
                                                 ------      ---       ----      --- 

        Total .............................      $1,686      100%      $930      100%
                                                 ======      ===       ====      === 
</TABLE>

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

(1)      The Bank had no foreign loans.


Deposits

         The average amounts of and the average rate paid on each of the
following categories of deposits for the years ended December 31, 1998 and 1997
are as follows:

<TABLE>
<CAPTION>
                                                     Years ended December 31,
                                          --------------------------------------------
                                                   1998                   1997
                                          --------------------    --------------------
                                          Amount          Rate    Amount          Rate
                                          ------          ----    ------          ----
                                           (amounts in thousands, except percentages)
<S>                                      <C>              <C>     <C>             <C>
Noninterest-bearing demand deposits      $  3,940          -0-%   $ 3,527          -0-%

Demand ............................        30,238         4.78%    22,681         4.92%
Savings ...........................        24,463         4.95%    17,984         5.19%
Time deposits .....................        52,104         6.21%    45,616         6.27%
                                         --------                 -------
    Total interest-bearing deposits       106,805         5.47%    86,281         5.69%
                                         --------                 -------
       Total average deposits .....      $110,745         5.32%   $89,808         5.47%
                                         ========                 =======
</TABLE>


                  (Remainder of Page Intentionally Left Blank)



                                       22
<PAGE>   25


         The two categories of lowest cost deposits comprised the following
percentages of average total deposits during 1998: average noninterest-bearing
demand deposits, 3.6 percent; and average interest-bearing demand deposits, 27.3
percent. Of average time deposits, approximately 13.7 percent were large
denomination certificates of deposit. The maturities of the time certificates of
deposit of $100,000 or more issued by the Bank at December 31, 1998 are
summarized in the table below.

                        Maturities of Large Time Deposits
<TABLE>
<CAPTION>
                                                Time
                                            Certificates
                                             of Deposit
                                             ----------
                                        (amounts in thousands)
<S>                                         <C>    
Three months or less .........                $ 5,255
Over three through six months                   4,529
Over six through twelve months                  8,469
Over twelve months ...........                  7,695
                                              -------

  Total ...................                   $25,948
                                              =======
</TABLE>


Return on Equity and Assets

         The following table summarizes certain financial ratios for the Company
for the years ended December 31, 1998 and 1997.

                           Return on Equity and Assets

<TABLE>
<CAPTION>
                                            Years ended December 31,
                                            ------------------------
                                               1998          1997
                                            ---------      ---------

<S>                                         <C>            <C> 
Return on average assets .............           .92%        .98%
Return on average equity .............         13.50       15.90
Dividend payout ratio ................           -0-         -0-
Average equity to average assets ratio          6.80        6.19
</TABLE>


                  (Remainder of Page Intentionally Left Blank)





                                       23
<PAGE>   26



                      SELECTED CONSOLIDATED FINANCIAL DATA

         The following table sets forth selected consolidated financial data of
the Company for the years ended December 31, 1998, 1997 and 1996. All averages
are daily averages.

<TABLE>
<CAPTION>
                                                                                              Years ended December 31,
                                                                             ------------------------------------------------------
                                                                                     1998             1997                1996
                                                                             -----------------    -------------     ---------------
                                                                             (amounts in thousands except per share data and ratios)
<S>                                                                          <C>                  <C>               <C>        
Consolidated Statement of Operations Data
   Interest income........................................................       $    11,271      $     9,143       $     6,311
   Interest expense.......................................................             6,498            5,262             3,660
   Net interest income....................................................             4,773            3,881             2,651
   Provision for loan losses..............................................               300              480               368
   Non-interest income....................................................               529              385               253
   Non-interest expense...................................................             3,221            2,385             1,715
   Net income.............................................................             1,208            1,018               517

Per Share Data
   Net income - basic.....................................................              1.04%             .88               .45
   Net income - diluted...................................................               .99%             .87               .45
   Cash dividends.........................................................               -0-%             -0-               -0-
   Shareholders' equity (book value) at period end .......................              8.68%            6.04              5.10

Consolidated Balance Sheet Data
   Loans..................................................................       $   129,831      $    84,584       $    64,962
   Deposits...............................................................           163,861           95,348            81,148
   Average equity.........................................................             8,925            6,392             5,503
   Average assets.........................................................           131,079          103,261            72,346
   Total assets...........................................................           189,745          112,181            93,154

Ratios
   Return on average assets...............................................              .92%              .98%              .71%
   Return on average equity...............................................            13.50             15.90              9.40
   Dividend payout ratio..................................................              -0-               -0-               -0-
   Average equity to average assets.......................................             6.80              6.19              7.61
   Total capital..........................................................             7.88              9.33             10.30
   Tier 1 capital.........................................................             6.64              8.23              9.40
   Leverage ratio.........................................................             4.99              6.40              5.90
</TABLE>


Item 2.   Properties

         The Company's offices are located in the Gilmer County Bank's main
office at 829 Industrial Boulevard, Ellijay, Georgia, between the business
districts of Ellijay and East Ellijay. The office building, which contains 9,780
square feet, and the land on which it is located, which is approximately 1.22
acres, are owned by Gilmer County Bank. The building houses offices, operations,
storage, and a lobby. The main banking office of First National is located at
236 Highway 515, Blairsville, Georgia. This office, which opened in November
1996 and contains approximately 11,900 square feet, and the land on which it is
located are owned by First National.

         In May 1998, the Company purchased a 1,250 sq. ft. brick building near
Gilmer County Bank's existing facility for a purchase price of $155,000. The
building is located on seven-tenths of an acre. On March 29, 1999, the Company
sold the building and the property for $155,000.



                                       24
<PAGE>   27

         In October 1998, the Company entered into a lease for an 0.88 acre
parcel of unimproved land located on First Avenue in East Ellijay, Gilmer
County, Georgia. The lease commenced on January 1, 1999 and has a 30 year term.
The lease payments are $2,500 per annum initially, and increase at a rate of 2%
per annum starting in the fourth year of the lease. The Company plans to use the
land to build a branch office of Gilmer County Bank, although no date has been
set for such expansion.

         Management believes that the physical facilities maintained by the
Banks are suitable for its current operations.

Item 3.   Legal Proceedings

         The Company is not aware of any material pending legal proceedings to
which the Company or the Banks are a party or to which any of their property is
subject, other than ordinary routine legal proceedings incidental to the
business of the Banks.

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

         No matters were submitted to a vote of shareholders of the Company
during the fourth quarter of the fiscal year covered by this Report.


                  (Remainder of Page Intentionally Left Blank)



                                       25
<PAGE>   28


                                     PART II

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

Market Information

         There is no established trading market for the Company's Common Stock,
$5.00 par value (the "Common Stock"), which has been traded inactively in
private transactions. Therefore, no reliable information is available as to
trades of the Common Stock or as to the prices at which Common Stock has traded.
In 1998, Interstate/Johnson Lane Corporation was approved as a market maker for
the Company's Common Stock.

         In May 1998, the Company effected a two-for-one share split of its
Common Stock (the "Stock Split") in the form of a common stock dividend, payable
on or about May 15, 1998 to shareholders of record as of the close of business
on May 1, 1998. All amounts presented in this Report and in the financial
statements are adjusted to reflect the Stock Split. This net effect of the Stock
Split did not change total shareholders' equity.

         Management has reviewed the limited information available as to the
ranges at which the Common Stock has been sold. The following table sets forth
the estimated price range for sales of Common Stock for each quarter of the last
two fiscal years, as adjusted for the Stock Split on May 15, 1998. The following
data regarding the Common Stock is provided for information purposes only and
should not be viewed as indicative of the actual or market value of the Common
Stock.

<TABLE>
<CAPTION>

                                                                                   Estimated Price Range
                                                                                          Per Share
                                                                                   ---------------------

                                                                                   High            Low
                                                                                   ----            ---
         <S>                                                                       <C>            <C> 
         1997:
         First Quarter.......................................................      $ 8.00         $ 8.00
         Second Quarter......................................................        9.25           9.00
         Third Quarter.......................................................       11.00           8.00
         Fourth Quarter......................................................       10.50           9.25

         1998:
         First Quarter.......................................................      $11.75         $11.75
         Second Quarter......................................................       15.00          15.00
         Third Quarter.......................................................       20.00          15.00
         Fourth Quarter......................................................       20.00          20.00
</TABLE>

         At March 29, 1999, the Company had 1,323,188 shares of Common Stock
outstanding held by approximately 768 shareholders of record.

Recent Sales of Unregistered Securities

         In November 30, 1998, the Company sold 132,500 shares of the Company's
Common Stock in a private placement to three institutional accredited investor
at a price of $20.00 per share. The aggregate gross proceeds of the private
placement were $2.65 million. The Company used all of the proceeds to fund a
portion of the purchase price of its acquisition of First National. Under the
terms of the private placement, each of the purchasers is entitled to certain
registration rights with respect to the shares of Common Stock purchased by such
purchaser.

         On November 30, 1998, the Company issued 10,668 shares of its Common
Stock to the Company's 401(k) plan at a price of $20.00 (total purchase price of
$213,360). On March 16, 1998, the Company issued 8,646 shares of its Common
Stock to the Company's 401(k) plan at a price of $11.25 per shares (total
purchase price of $97,267.50). On


                                       26
<PAGE>   29

February 26, 1998, the Company repurchased 14,000 shares of its Common Stock
from one of the Company's directors at a price of $11.00 per share (total
purchase price of $154,000).

Dividends

         Gilmer County Bank is subject to restrictions on the payment of
dividends under Georgia law and the regulations of the DBF. First National is
subject to restrictions on the payment of dividends under federal law and the
regulations of the OCC. In March 1998, Gilmer County Bank paid a $500,000
dividend to the Company, which was used by the Company for repayment of debt and
other expenses.

         The Company is also subject to limits on payment of dividends by the
rules, regulations and policies of federal banking authorities. See "Supervision
and Regulation--Dividends." The primary source of funds available for the
payment of cash dividends by the Company are dividends from the Banks. There are
various statutory and regulatory limitations on the payment of dividends by the
Banks, as well as by the Company to its shareholders. No assurance can be given
that any dividends will be declared by the Company in the future, or if
declared, what amounts would be declared or whether such dividends would
continue. The Company has not paid any dividends to date.


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

         The purpose of the following discussion is to address information
relating to the financial condition and results of operations of the Company
that may not be readily apparent from a review of the consolidated financial
statements and notes thereto, which begin on page F-1 of this Report. This
discussion should be read in conjunction with information provided in the
Company's consolidated financial statements and accompanying footnotes, and with
the statistical information appearing elsewhere in this Report under the caption
"Selected Statistical Information." Unless otherwise noted, the discussion of
net interest income in this financial review is presented on a taxable
equivalent basis to facilitate performance comparisons among various taxable and
tax-exempt assets.

Results of Operations

         Earnings Summary

         The Company's net income of $1,208,231 for the year ended December 31,
1998 represents an increase of $190,425 from the net income of $1,017,766 for
the year ended December 31, 1997. The Company's net income in 1997 represented
an increase of $501,030 over net income of $516,736 in 1996. The increase in net
income for these periods relates to the growth in the Gilmer County Bank's
deposit and loan base as well as an increase in Gilmer County Bank's net
interest margin and interest rate spread.

         After restatement for the 2-for-1 stock split in 1998, earnings per
share increased to $1.04 ($.99 on a fully diluted basis) in 1998 compared to a
$.88 per share net income in 1997 and a $0.45 per share net income in 1996.
Return on average assets, which reflects the Banks' abilities to utilize their
assets, was .92% in 1998, compared with .98% in 1997 and .71% in 1996. Return on
average shareholders' equity decreased to 13.5% in 1998 compared with 15.9% in
1997, due to the acquisition of First National.


                                       27
<PAGE>   30

Comparison of Years Ended December 31, 1998 and 1997

         Net Interest Income

         Net interest income is the principal source of the Banks' earnings
stream and represents the difference or spread between interest and fee income
generated from earning assets and the interest expense paid on deposits and
borrowed funds. Fluctuations in interest rates as well as volume and mix changes
in earning assets and interest-bearing liabilities materially impact net
interest income. Net interest income was $4,772,773 in 1998, compared to
$3,880,715 in 1997, representing an increase of 23.0%. This increase was caused
by the growth of the Bank's deposit base and loan portfolio.

         Interest and fees earned on loans increased 25.6% from $7,652,481 in
1997 to $9,614,165 in 1998. The increase was primarily from the increase in
volume of average loans from approximately $74,753,000 in 1997 to approximately
$95,353,000 in 1998.

         Interest earned on taxable securities decreased 13.1% from $1,160,497
in 1997 to $1,009,595 in 1998, while interest earned on non-taxable securities
increased from $205,883 to $376,157 during the same period. The variance in the
income figures reflects management's strategy to decrease income taxes by
investing in tax-free municipal bonds.

         The trend in net interest income is also evaluated in terms of average
rates using the net interest margin and the interest rate spread. The net
interest margin, or the net yield on earning assets, is computed by dividing
fully taxable equivalent net interest income by average earning assets. This
ratio represents the difference between the average yield returned on average
earning assets and the average rate paid for funds used to support those earning
assets, including both interest-bearing and noninterest-bearing sources. The net
interest margin for 1998 was 4.04% compared to a net interest rate margin of
4.06% in 1997.

         The interest rate spread measures the difference between the average
yield on earning assets and the average rate paid on interest-bearing sources of
funds. The interest rate spread calculation provides a more direct perspective
on the effect of market interest rate movements. The net interest spread was
3.76% in 1998 compared to 3.73% in 1997.

         The following tabulation presents certain net interest income data
without modification for assumed tax equivalency:

<TABLE>
<CAPTION>

                                                                                Years ended December 31,

                                                                          1998            1997             1996
                                                                       ------------    -----------    ------------
<S>                                                                       <C>             <C>              <C> 

Rate earned on earning assets......................................        9.30%         9.40%            9.22%
Rate paid on borrowed funds........................................        5.54%         5.67%            5.73%
Interest rate spread...............................................        3.76%         3.73%            3.49%
Net yield on earning assets........................................        4.04%         4.06%            3.90%

</TABLE>

         During 1998, interest on federal funds sold increased $109,396 (68.5%)
from 1997. This increase in income is the result of maintaining larger average
federal funds balances with correspondent banks of approximately $4,448,000 and
$2,895,000 in 1998 and 1997, respectively. The average yield for such years was
6.09% and 5.53%, respectively.

         Interest Expense

         Total interest expense increased $1,235,966 (23.5%) from $5,262,253 in
1997 to $6,498,219 in 1998. This increase was the combined effect of an increase
in the average balance of interest-bearing deposits to approximately


                                       28
<PAGE>   31

$106,805,000 in 1998 from approximately $86,281,000 in 1997. The average rate
paid on deposits in 1998 and 1997, respectively was 5.47% and 5.69%. The effect
of these changes increased the interest expense on interest-bearing deposits to
$5,891,778 in 1998 from $4,911,266 in 1997, and increase of $980,532 (20.0%).

         Noninterest Income

         Noninterest income for 1998 and 1997 totaled $528,921 and $378,996,
respectively. These amounts are primarily from service charges on deposit
accounts, insurance commissions and fees on services to customers. Noninterest
income increased primarily due to the continued growth in the Banks' deposit
base. Other operating income increased from $161,086 in 1997 to $251,717 in
1998, primarily due to an increase in credit card fees earned by the Banks.

         Noninterest Expenses

         Noninterest expenses totaled $3,221,213 in 1998 and $2,379,358 in 1997.
Salaries and benefits increased $342,287 (29.6%) to $1,496,743 in 1998, due to
the Banks' increased staffing to accommodate the growth in the Banks' loans and
deposits, as well as, the acquisition of First National in November 1998.
Furniture and equipment expenses increased $102,448 (68.1%) in 1998 due to
increased data processing costs and the cost associated with expanded
facilities. Other operating expenses increased $321,353 (32.9%) to 1,298,630 in
1998 due mainly to increase in advertising and supplies.

         The table below sets forth the Company's noninterest expenses for the
periods indicated.

<TABLE>
<CAPTION>
                                                                                    Years ended December 31,

                                                                           1998           1997               1996
                                                                        ----------     ----------         ----------
                                                                                   (amounts in thousands)

<S>                                                                     <C>            <C>   <C>          <C>
Salaries and employee benefits....................................      $  1,438       $   1,154          $    893
Occupancy expense.................................................           173              96                96
Furniture and equipment expense...................................           253             150               126
Director and committee fees.......................................           127             119                19
Advertising.......................................................           191             122                93
Checking account expense..........................................            39              33                29
Data processing...................................................           128              87                47
Insurance.........................................................            52              56                27
Postage...........................................................            87              70                52
Professional and regulatory fees..................................           146             195               121
Supplies..........................................................           143             117               106
Correspondent bank charges........................................            35              35               -0-
Taxes and licenses................................................            36              26                22
Other.............................................................           373             119                84
                                                                        ----------     ----------         ----------
  Total...........................................................      $    3,221     $    2,379         $    1,715
                                                                        ==========     ==========         ==========
</TABLE>


         Income Taxes

         The Company's net operating income of $1,780,481 in 1998 resulted in
$572,250 (32.1%) of income tax expense. Net operating income for 1997 was
$1,400,353 with a related income tax expense of $382,587.

Comparison of Years Ended December 31, 1997 and 1996

         Net Interest Income

                                       29

<PAGE>   32

         Net interest income was $3,880,715 in 1997, as compared to $2,651,070
in 1996, representing an increase of $1,229,645, or 46.4%. This increase was
caused by the growth of Gilmer County Bank's deposit base and loan portfolio as
well as an increase in the Gilmer County Bank's interest rate spread and net
interest margin.

         Interest earned on fees and loans increased from $5,205,131 in 1996 to
$7,652,481 in 1997, an increase of $2,447,350 or approximately 47%. This
increase was caused by the increase in the average loan portfolio balance from
approximately $51,008,000 in 1996 to approximately $74,753,000 in 1997.

         Interest earned on taxable investment securities increased $182,580
(18.7%) from $977,917 in 1996 to $1,160,497 in 1997 while interest earned on
nontaxable investment securities increased from $24,228 in 1996 to $170,274 in
1997. The increase in interest earned on nontaxable securities in 1997 is a
result of an increase of approximately $2,812,000 (632%) in the average
investment portfolio for such securities from 1996.

         The trend in net interest income is also evaluated in terms of average
rates using the net interest margin and the interest rate spread. The net
interest margin, or the net yield on earning assets, is computed by dividing
fully taxable equivalent net interest income by average earning assets. This
ratio represents the difference between the average yield returned on average
earning assets and the average rate paid for funds used to support those earning
assets, including both interest-bearing and noninterest-bearing sources. The net
interest margin for 1997 was 4.06%, compared with a net interest rate margin of
3.90% in 1996. This increase was due primarily to the growth of the Bank related
specifically to an increase in interest-bearing assets as a percentage of
interest-earning liabilities.

         The interest rate spread measures the difference between the average
yield on earning assets and the average rate paid on interest-bearing sources of
funds. The interest rate spread calculation provides a more direct perspective
on the effect of market interest rate movements. The net interest spread for
1997 was 3.73% from earning assets as compared to a net interest spread of 3.49%
in 1996.

         During 1997, interest on federal funds sold increased $55,695 (53.5%)
from 1996. The increase in income from federal funds sold is the result of an
increase in the average amount of federal funds sold from approximately
$2,025,000 in 1996 to approximately $2,895,000 in 1997 and an increase in the
average yield for such funds from 5.14% in 1996 to 5.53% in 1997.

         Interest Expense

         Total interest expense increased $1,602,026 (43.8%), from $3,660,227 in
1996 to $5,262,253 in 1997. This increase was the combined effect of an increase
in the average balance of interest-bearing deposits from approximately
$59,043,000 in 1996 to approximately $86,281,000 in 1997 and a decrease in the
average rate paid on deposits from 5.82% in 1996 to 5.69% in 1997. The effect of
these changes increased the interest expense on interest-bearing deposits from
$3,436,060 in 1996 to $4,911,266 in 1997.

         Noninterest Income

         Noninterest income for 1997 and 1996 totaled $384,831 and $252,946,
respectively. These amounts are primarily from service charges on deposit
accounts, insurance commissions and fees on services to customers. Noninterest
income increased primarily due to the continued growth in Gilmer County Bank's
deposit base. Other noninterest income increased from $85,055 in 1996 to
$161,086 in 1997, primarily due to an increase of approximately $39,562 in
credit card fees earned by the Bank in 1997.

         Noninterest Expenses

         Noninterest expenses totaled $2,379,358 in 1997 and $1,715,372 in 1996.
Salaries and benefits increased $261,464 (29.3%) to $1,154,456, which reflects
the Bank's increased staffing to accommodate the growth in Gilmer County Bank's
loans and deposits. Furniture and equipment expenses increased $23,919 (18.9%)
primarily due to depreciation on equipment of $98,296 in 1997 ($8,070 over 1996)
and repair and maintenance costs of $51,671 


                                       30
<PAGE>   33

($15,459 over 1996). Other operating expenses increased $377,501 (62.9%).
Directors' fees increased $100,422 due to payments made by the Company in the
first full year the Company paid directors' fees. The $73,411 increase in
professional fees was primarily attributable to compliance with reporting
requirements under the federal securities laws.


         Income Taxes

         The Company attempts to maximize its net income through active tax
planning. This planning resulted in a provision for income taxes of $382,587
(27.3%) for 1997 on pre-tax income of $1,400,353. The tax for 1996 was $303,908
(37%) on income of $820,644 and for 1995 was a benefit of ($126,952) (34%) on a
loss of $373,644. The 1997 tax amount and rate is lower than the statutory
federal tax rate of 34 percent primarily due to investments in loans and
securities earning interest income that is exempt from federal taxation. In 1997
the effective tax rate was 80.3 percent of the statutory federal tax rate
compared to 108.8 percent in 1996. A more detailed explanation of income tax
expense is included in the accompanying Notes to Consolidated Financial
Statements.

Financial Condition

         Earning Assets

         The Banks' earning assets, which include deposits in other banks,
federal funds sold, securities and loans, averaged $123,663,000 in 1998 or 94.3%
of average total assets compared to $98,403,000 or 95.3% of average total assets
in 1997. The mix of average earning assets comprised the following percentages:


<TABLE>
<CAPTION>

                                                                1998            1997
                                                              --------        --------
<S>                                                           <C>             <C> 
Deposits in other banks.....................................      -0-%            -0-%
Federal funds sold..........................................     3.60%            2.94%
Investment securities.......................................    19.30%           21.10%
Loans.......................................................    77.20%           75.96%
</TABLE>


         The mix of average earning assets reflects management's attempt to
maximize interest income while maintaining acceptable levels of risk.

         The Banks have intentionally avoided the growing national market in
loans to finance leveraged buy-outs, participating in no nationally syndicated
leveraged buy-out loans. Concurrently, it has avoided exposure to lesser
developed country ("LDC") debt, having no LDC loans in its portfolio.

         Loans

         Loans made up the largest component of the Banks' earning assets. At
December 31, 1998, the Banks' total loans were $129,831,095 compared to total
loans of $84,583,853 at the end of 1997. In 1998, average net loans represented
77.1% of average earning assets and 72.7% of total average assets, while in
1997, average net loans represented 76.0% of average earning assets and 72.4% of
average total assets. This was the result of an increase in loan demand in the
Banks' market area, combined with an increase in the Banks' market share of
loans in such area. The ratio of total loans to total deposits was 79.2% in
1998, and 88.7% in 1997.

         Securities and Federal Funds Sold

         The Banks have classified their securities as either available-for-sale
or held-to-maturity, depending on whether the Banks have the intent and ability
to hold such securities to maturity. At December 31, 1998, $21,940,281 was
classified as available-for-sale, while at December 31, 1997, $15,544,585 of the
Banks' securities were classified as available-for-sale. Securities classified
as held-to-maturity were $6,218,354 at year-end 1998, and $4,181,021 at year-end
1997.


                                       31
<PAGE>   34

         The composition of the Banks' securities portfolio reflects the
Company's investment strategy of maximizing portfolio yields subject to risk and
liquidity considerations. The primary objectives of the Company's investment
strategy are to maintain an appropriate level of liquidity and to provide a tool
to assist in controlling the Banks' interest rate position while at the same
time producing adequate levels of interest income. For securities classified as
held-to-maturity, it is the Company's intentions for the Banks to hold such
securities for the foreseeable future. Management of the maturity of the
portfolio is necessary to provide liquidity and to control interest rate risk.
During 1998, gross sales amounted to $9,515,761 and maturities amounted to
$11,597,617, representing 40% and 55.9% of the average portfolio, respectively.
Net gains associated with these transactions were $15,950. Gross unrealized
gains at year end 1998 amounted to $423,178 and unrealized losses amounted to
$30,074. During 1997, gross securities sales were $9,982,814 and maturities were
$8,513,974 representing 48.1% and 41.0%, respectively, of the average portfolio
for the year. Net losses associated with sales and maturities totaled $78 in
1997. Gross unrealized gains in the portfolio amounted to $171,823 at year end
1997 and unrealized losses amounted to $29,090.

         Mortgage-backed securities have varying degrees of risk of impairment
of principal, as opposed to U.S. Treasury and U.S. government agency
obligations, which are considered to contain virtually no default or prepayment
risk. Impairment risk is primarily associated with accelerated prepayments,
particularly with respect to longer maturities purchased at a premium and
interest-only strip securities. The Banks' purchases of mortgage-backed
securities during 1998 and 1997 did not include securities with these
characteristics. The recoverability of the Banks' investments in mortgage-backed
securities is reviewed periodically, and the Company intends to make appropriate
adjustments to income for impaired values.

         Management maintains federal funds sold as a tool in managing its daily
cash needs. Federal funds sold at December 31, 1998, was $18,392,213 and
$1,828,000 in 1997. Average federal funds sold for 1998 was approximately
$4,448,000 or 3.6% of average earning assets, and for 1997 was $2,895,000 or
2.9% of average earning assets. The large increase in year end federal funds
resulted from the acquisition of First National and effective management of
interest yield.

         There has been no significant impact on the Company's financial
statements as a result of the provisions of Statement of Financial Accounting
Standards No. 119, Disclosure about Derivative Financial Instruments and Fair
Value of Financial Instruments.

         Deposits and Repurchases

         The Company's primary source of funds is derived from deposits of the
Banks' customers. Average deposits increased 23.3% from approximately
$89,808,000 in 1997 to approximately $110,745,000 in 1998. At December 31, 1998
total deposits were $163,861,478 of which $154,573,545 (94.3%) were interest
bearing. At December 31, 1997, total deposits were $95,347,946, of which
$91,547,035 (96%) were interest bearing. The acquisition of First National, as
well as the continued enhancement of existing products and emphasis upon better
customer service, fueled the growth in the deposit base. The Company intends to
emphasize attracting consumer deposits in order to expand the consumer bases of
the Banks and to continue to fund asset growth.

         Securities sold under agreements to repurchase amounted to $2,478,344
at December 31, 1998 compared to $4,228,129 at December 31, 1997. The weighted
average rates were 4.26% and 4.50% for 1998 and 1997, respectively. Securities
sold under agreements to repurchase averaged $4,095,716 during 1998 and
$4,471,499 during 1997. The maximum amount outstanding at any month end during
1998 was $4,468,355 and $4,693,265 during 1997. The total of securities sold
under agreements to repurchase are associated with the cash flow needs of our
corporate customers that participate in repurchase agreements.

Shareholders' Equity

         Shareholders' equity increased $4,499,641 from December 31, 1997 to
December 31, 1998, due in part to net earnings of $1,208,211 and the increase in
unrealized gains on securities available-for-sale totaling $90,542, net 


                                       32
<PAGE>   35

of deferred tax liability. The increase was also a result of the issuance of
19,314 shares of the Company's common stock to the Company's 401(k) plan (total
purchase price $310,628), the sale of 132,500 shares of stock in a private
placement in November 1998 (aggregate proceeds $2,650,000), and the issuance of
30,800 shares in connection with the exercise of options by the certain of the
Company's directors (aggregate proceeds $394,240). The decrease in Shareholders'
equity resulting from the purchase of 14,000 shares of Common Stock by the
Company on February 26, 1998 from one of the Company's directors at a price of
$11.00 per share (total purchase price of $154,000).

         All amounts presented in this Report and in the financial statements
are adjusted to reflect the Stock Split in May 1998. This net effect of the
Stock Split did not change total Shareholders' equity. See "Market Information".

Liquidity and Capital Resources

         Year 2000

         The Company utilizes and is dependent upon data processing systems and
software to conduct its business. The approach of the Year 2000 presents a
problem in that many computer programs have been written using two digits rather
than four to define the applicable year. Computer programs that have
time-sensitive software may recognize a date using "00" as the year 1900 rather
than the Year 2000. For example, computer systems may compute payment, interest,
delinquency or other figures important to the operations of the Company based on
the wrong date. This could result in internal system failure or miscalculation,
and also creates risk for the Company from third parties with whom the Company
deals on financial transactions.

         The FDIC has issued guidelines for insured financial institutions with
respect to Year 2000 compliance. The Company has developed a Year 2000 action
plan based in part on the guidelines and timetables issued by the FDIC. The
Company's action plan focuses on four primary areas: (1) information systems,
(2) embedded systems located at the Banks' offices and within its off-site ATM
machines, (3) third party and customer relationships, and (4) contingency
planning. The Company has designated a Year 2000 compliance team, headed by its
Chief Financial Officer and Chief Operating Officer, who reports to the board of
directors. In addition, the Company has engaged outside consultants for purposes
of conducting Year 2000 readiness assessments and remediation where necessary.

         Information Systems. The Company has identified all mission critical
information ("IT") systems and has developed a schedule for testing and
remediation of such systems. Testing of key computer hardware has been
completed, and the Company has completed modification and replacement of its
mission critical hardware that was not Year 2000 compliant. The Company has
completed its inventory of mission critical software and is in the process of
contacting software vendors for certification of Year 2000 compliance, which the
Company expects to complete in the second quarter of 1999. The Company plans to
complete any programming changes to critical systems and commence testing of the
new programming in the early part of the second quarter of 1999. Testing of
internal mission-critical systems commenced during the first quarter of 1999 and
implementation is scheduled to be completed by June 30, 1999.

         Embedded Systems. The Company is performing a comprehensive inventory
of its embedded systems, such as microcontrollers used to operate security
systems and elevators, and has completed its inventory of mission critical
non-IT systems. The Company is in the process of contacting manufacturers and
vendors of those components utilized in operations to determine whether such
components are Year 2000 compliant. The Company intends to remediate or replace,
as applicable, any non-compliant components and expects to complete this process
for mission critical systems by June 30, 1999. The quality of the responses from
manufacturers and vendors, the estimated impact of the individual system or
component on the Banks' operations, and the ability of the Company to perform
meaningful and verifiable tests will influence its decision regarding whether to
have independent tests conducted on its embedded systems.


                                       33
<PAGE>   36

         Third Party and Customer Relationships. The Company is in the process
of initiating communications with all suppliers and vendors to determine the
potential impact of such third parties' failure to remediate their own Year 2000
issues. These third parties include other financial institutions, office supply
vendors and telephone, electric and other utility companies. The Company is
encouraging its counterparties and customers to conduct their own Year 2000
assessment and take appropriate steps to become Year 2000 compliant.

         The Company outsources its principal data processing activities to
another financial institution, and the Company is actively communicating with
and monitoring the progress of such institution to assess the impact of Year
2000 issues on such institution and its ability to provide such data processing
services. The Company will consider new business relationships with alternate
providers of products and services if necessary. Additionally, the Company has
initiated communications with its larger and commercial borrowers to assess the
potential impact of Year 2000 on them and their ability to remain current on
loan repayments.

         Contingency Plans. As part of the Company's normal business practice,
it maintains contingency plans to follow in the event of emergency situations,
some of which could arise from Year 2000-related problems. The Company is in the
process of formulating a detailed Year 2000 contingency plan, which will assess
several possible scenarios to which the Company may be required to react. The
Company's formal Year 2000 contingency plan is expected to be completed by the
end of second quarter 1999.

         Financial Implications. The Company believes that, since a majority of
its equipment is relatively new, the Year 2000 problem will not pose significant
internal operational problems or generate material additional expenditures.
Maintenance, testing, and modification costs will be expensed as incurred, while
the costs of new software or hardware will be capitalized and amortized over
their useful lives. Management currently does not expect the amounts required to
be expensed to resolve Year 2000 issues to have a material effect on its
financial position or results of operations. In connection with its assessment,
testing and remediation of Year 2000 issues, the Company incurred costs of
approximately $10,000 in 1998. The Company currently estimates that the costs of
assessing, testing and remediation of Year 2000 issues will total approximately
$80,000 in 1999. The anticipated costs associated with the Company's Year 2000
compliance program do not include time and costs that may be incurred as a
result of any potential failure of third parties to become Year 2000 compliant
or costs to implement the Company's contingency plans. The Company is funding
its costs associated with the Year 2000 issue through its regular operating
income. While the Company does not expect the cost of these efforts to be
material to its financial position or its operating results, there can be no
assurance to this effect.

         Potential Risks. The Year 2000 issue presents a number of risks to the
business and financial condition of the Company and the Banks. External factors,
which include but are not limited to electric and telephone service, are beyond
the control of the Company and the failure of such systems could have a material
adverse effect on the Company, its customers and third parties on whom the
Company relies for its day-to-day operations. The business of many of the
Company's customers may be negatively affected by the Year 2000 issue, and any
financial difficulties incurred by the Company's customers in connection with
the century change could negatively affect such customers' ability to repay
loans to the Company. The failure of the Banks' computer system or applications
or those operated by customers or third parties could have a material adverse
effect on the Company's results of operations and financial condition.

         In light of its compliance efforts, the Company does not believe that
the Year 2000 issue will materially adversely effect operations or results of
operations, and does not expect implementation to have a material impact on its
business, financial condition or operating results. However, there can be no
assurance that the Company's and the Banks' systems will be Year 2000 ready
prior to December 31, 1999, or that the failure of any such system will not have
a material adverse effect on the Company's business, financial condition or
operating results. In addition, to the extent the Year 2000 issue has a material
adverse effect on the business, financial condition or operating results of
third parties which whom the Company has material relationships, such as other
financial institutions, the Year 2000 issue could have a material adverse effect
on the Company's business, financial condition or operating results.

         The foregoing are forward-looking statements reflecting management's
current assessment and estimates


                                       34
<PAGE>   37

with respect to the Company's Year 2000 compliance efforts and the impact of
Year 2000 issues on the Company's business and operations. Various factors could
cause actual plans and results to differ materially from those contemplated by
such assessments, estimates and forward-looking statements, many of which are
beyond the control of the Company. Some of these factors include, but are not
limited to, representations by the Company's vendors and counterparties,
technological advances, economic considerations, and consumer perceptions. The
Company's Year 2000 compliance program is an ongoing process involving continual
evaluation and may be subject to change in response to new developments.

         Liquidity Management

         Liquidity is defined as the ability of a company to convert assets into
cash or cash equivalents without significant loss. Liquidity management involves
maintaining the Banks' abilities to meet the day-to-day cash flow requirements
of its customers, whether they are depositors wishing to withdraw funds or
borrowers requiring funds to meet their credit needs. Without proper liquidity
management, the Banks would not be able to perform the primary function of
financial intermediaries and would, therefore, not be able to meet the
production and growth needs of the communities it serves.

         The primary function of assets and liabilities management is not only
to assure adequate liquidity in order for the Banks to meet the needs of their
customer bases, but also to maintain an appropriate balance between
interest-sensitive assets and interest-sensitive liabilities so that the Company
can also meet the investment requirements of its shareholders. Daily monitoring
of the sources and uses of funds is necessary to maintain an acceptable cash
position that meets both requirements. In the banking environment, both assets
and liabilities are considered sources of liquidity funding and both are,
therefore, monitored on a daily basis.

         The asset portion of the balance sheet provides liquidity primarily
through loan principal repayments or sales of investment and trading account
securities. Real estate construction and commercial, financial and agricultural
loans that mature in one year or less equaled approximately $23.0 million or
17.8% of the total loan portfolio at December 31, 1998 and investment securities
maturing in one year or less equaled $2.1 million or 7.3% of the portfolio.
Other sources of liquidity include short-term investments such as federal funds
sold.

         The liability portion of the balance sheet provides liquidity through
various customers' interest-bearing and noninterest-bearing deposit accounts. At
the end of fiscal 1998, funds were also available through the purchase of
federal funds from correspondent commercial banks from available lines of up to
an aggregate of $4,000,000.

         In an effort to maintain and improve the liquidity position of Gilmer
County Bank, management made application for membership with the Federal Home
Loan Bank of Atlanta in 1997. As a member of the Federal Home Loan Bank, Gilmer
County Bank is able to improve its ability to manage liquidity and reduce
interest rate risk by having a funding source to match longer term loans. The
application was approved on April 17, 1997, and Gilmer County Bank received an
initial credit line of up to $8,000,000. Gilmer County Bank's credit line was
increased to $12,000,000 in March 1998. At December 31, 1998, the outstanding
balance of Gilmer County Bank's credit line was $7,407,143. See Note 9 to the
Notes to Consolidated Financial Statements herein. First National also has a
credit line with the Federal Home Loan Bank, which provides for a credit line of
up to $6,000,000. At December 31, 1998, First National did not have an
outstanding balance on its credit line.

         Capital Resources

         A strong capital position is vital to the continued profitability of
the Company because it promotes depositor and investor confidence and provides a
solid foundation for future growth of the organization. A majority of the
Company's capital requirements have been provided from the proceeds from Gilmer
County Bank's initial stock offering in 1994, through draws by Gilmer County
Bank on the credit line with the Federal Home Loan Bank, through draws on a line
of credit with Hardwick Bank and Trust Company (described below), through a $3.6
million loan from The Bankers Bank (described below), from the proceeds of the
$2.65 private placement of the


                                       35
<PAGE>   38

Common Stock in November 1998, and through the retention of earnings and the
sale of Company stock to the Company's 401(k) plan.

         Term Loan. In November 1998, the Company obtained a $3.6 million term
loan under a Loan and Stock Pledge Agreement and a Promissory Note
(collectively, the "Term Loan") with The Bankers Bank. The Company used $3.45 of
the proceeds of the Term Loan to fund a portion of its acquisition of First
National. The Company used the remaining $150,000 of the proceeds of the Term
Loan to repay a portion of principal amounts outstanding under its former line
of credit with Hardwick Bank & Trust Company ("Hardwick"). At December 31, 1998,
the balance on the Term Loan was $3.6 million. Interest on the outstanding
amounts under the Term Loan is payable quarterly, commencing January 1, 1999, at
the prime rate (as defined in the Promissory Note) less 3/4 of a percentage
point. The Company began making interest payments on January 1, 1999. Principal
is due in seven equal annual installments, each in the amount of $450,000, plus
accrued and unpaid interest, beginning on November 30, 2000. The entire
outstanding balance of the Term Loan, together with all accrued and unpaid
interest, is due and payable in a final installment on November 30, 2008. The
Term Loan contains certain affirmative and negative covenants, including, but
not limited to, requiring the Company to cause the Banks at all times to
maintain certain minimum capital ratios, maintain nonperforming assets below a
specified level, and maintain a minimum ratio of consolidated loan loss reserves
to total loans.

         Line of Credit. In November 1996, the Company obtained a $1 million
unsecured line of credit under an agreement (the "Line of Credit Agreement")
with Hardwick. On October 29, 1997 the Company and Hardwick agreed to a
modification of the Line of Credit Agreement increasing the amount of credit
available to the Company to $1.5 million. In November 1998, the Company paid off
the Line of Credit using part of the proceeds of the Term Loan together with the
dividend paid by Gilmer County Bank to the Company. Upon repayment of the Line
of Credit, the Company terminated the Line of Credit Agreement.

         Federal Capital Standards. Regulatory authorities are placing increased
emphasis on the maintenance of adequate capital. In 1990, new risk-based capital
requirements became effective under FDICIA. The guidelines take into
consideration risk factors, as defined by regulators, associated with various
categories of assets, both on and off the balance sheet. Under the guidelines,
capital strength is measured in two tiers which are used in conjunction with
risk-adjusted assets to determine the risk-based capital ratios. The Company's
Tier 1 capital, which consists of common equity, paid-in capital and retained
earnings (less intangible assets), amounted to $9.0 million at December 31,
1998. Tier 2 capital components include supplemental capital components such as
qualifying allowance for loan losses and qualifying subordinated debt. Tier 1
capital plus the Tier 2 capital components is referred to as Total Capital and
was $10.7 million at year-end 1998. The Company's percentage ratios as
calculated under regulatory guidelines were 6.64% and 7.88% for Tier 1 and Total
Capital, respectively, at year-end 1998. The Company's Tier 1 Capital exceeded
the minimum ratio of 4% whereas the Company's Total Capital was slightly under
the minimum ratio of 8%.

         The Company's failure to meet the minimum Total Capital ratio at
December 31, 1998 was primarily attributable to the amount of goodwill resulting
from the Company's acquisition of First National. Over future periods the
effects of the goodwill on the Company's Total Capital ratio will decrease as
the goodwill is amortized on a straight-line basis over a period of twenty 
years. Additionally, management intends to closely monitor the asset mix of the 
Banks and to take such additional steps as are necessary in order to avoid a 
future failure to meet the applicable minimum capital ratios. These additional 
steps may include limiting the payment of dividends by the Company or raising
additional capital. The Company, however, cannot be assured that such steps will
be successful or that the Company will be able to meet its minimum capital
ratios. The failure of the Company to meet its minimum capital ratios could
result in, among other things, increased scrutiny from applicable regulatory
authorities, a reduction in the permissible activities of the Company or a
default under the Company's credit facilities. Any of these events could have a
material adverse effect on the Company's business, financial condition and
results of operations.


         Another important indicator of capital adequacy in the banking industry
is the leverage ratio. The leverage ratio is defined as the ratio which
shareholders' equity, minus intangibles bears to total assets minus intangibles.
At December 31, 1998, the Company's leverage ratio was 4.99% exceeding the
regulatory minimum requirement of 4%.

                  (Remainder of Page Intentionally Left Blank)

                                       36
<PAGE>   39



         The table below illustrates the Company's regulatory capital ratios
under federal guidelines at December 31, 1998 and 1997:


<TABLE>
<CAPTION>
                                                  Capital Adequacy Ratios

                                                                                     Years ended December 31,
                                                                  Statutory      -------------------------------
                                                                   Minimum           1998               1997
                                                                -------------    -------------     -------------

                                                                                     (amounts in thousands,
                                                                                        except percentages)
<S>                                                             <C>              <C>                <C>    
Tier 1 Capital..........................................                         $  9,035           $  6,916
Tier 2 Capital..........................................                            1,686                930
                                                                                 --------           --------

Total Qualifying Capital................................                         $ 10,721           $  7,846
                                                                                 ========           ========
Risk Adjusted Total Assets (including
   off-balance-sheet exposures).........................                         $136,122           $ 84,074
                                                                                 ========           ========

Tier 1 Risk-Based Capital Ratio.........................             4.0%            6.64%              8.23%
                                                                                     
Total Risk-Basked Capital Ratio.........................             8.0%            7.88%              9.33%
                                                                                                   
Leverage Ratio..........................................             4.0%            4.99%              6.40%
</TABLE>


         Gilmer County Bank; DBF Capital Requirement. In addition to the capital
standards imposed by federal banking regulators, the DBF imposes a 6% primary
capital ratio on Gilmer County Bank. The DBF's standard is calculated as the
ratio of total equity to total assets, each as adjusted for unrealized gains and
losses on securities and allowances for loan losses. At December 31, 1998,
Gilmer County Bank's capital ratio as calculated under the DBF standard was
6.89%.

         In March 1998, Gilmer County Bank paid a $500,000 dividend to the
Company, which was used by the Company for the repayment of debt and other
expenses.

         In the first quarter of 1998, Gilmer County Bank completed several
expansion and renovation projects on its offices and grounds, including
construction of a community center. Total expenditures on these projects
aggregated $243,138 and were funded through current operations cash flow.

         First National.  The applicable federal guidelines require First
National to maintain a minimum risk-based total capital ratio of 8% and a Tier 1
risk-based capital ratio of 4%. At December 31, 1998, First National's total 
capital ratio was 12.7% and its Tier 1 capital ratio was 11.4%.

Interest Rate Sensitivity Management

         Interest rate sensitivity is a function of the repricing
characteristics of the Banks' portfolios of assets and liabilities. These
repricing characteristics are the time frames within which the interest-bearing
assets and liabilities are subject to change in interest rates either at
replacement or maturity during the life of the instruments. Sensitivity is
measured as the difference between the volume of assets and liabilities in the
Bank's current portfolio that are subject to repricing in future time periods.
The differences are known as interest sensitivity gaps and are usually
calculated separately for segments of time ranging from zero to thirty days,
thirty-one to ninety days, ninety-one days to one year, one to five years, over
five years and on a cumulative basis.


                                       37
<PAGE>   40


         The following tables show interest sensitivity gaps for these different
intervals as of December 31, 1998.

<TABLE>
<CAPTION>

                                            Interest Rate Sensitivity Analysis

                                               0-30         31-90       91-365         1-5       Over 5
                                               Days          Days        Days         Years       Years     Total
                                              -----         -----       ------        -----       -----     -----

<S>                                          <C>          <C>           <C>         <C>         <C>        <C>   
Interest-earning assets (1)
  Loans...................................   $ 10,236     $ 22,782      $ 34,425    $ 56,438    $  5,946   $ 129,827
  Securities:
    Taxable...............................        280          402         1,514       7,619       6,349      16,164
    Tax-exempt............................        150          -0-           203       1,211      10,430      11,994
  Time deposits in other banks............         99           99           -0-         209         -0-         407
  Federal funds sold......................     18,392          -0-           -0-         -0-         -0-      18,392
                                             --------     -------       -------     --------    --------    --------
                                               29,157       23,283        36,142      65,477      22,725     176,784
                                             --------     --------      --------    --------    --------    --------
Interest-bearing liabilities (2)
  Demand deposits (3).....................     16,014       16,013        16,013         -0-         -0-      48,040
  Savings deposits (3)....................      9,670        9,670         9,669         -0-         -0-      29,009
  Time deposits...........................      7,143       15,900        36,892      17,590         -0-      77,525
  Other short-term borrowings (3).........        826          826           826                               2,478
  Long-term debt..........................        -0-          -0-           -0-       2,150       8,857      11,007
                                             -------      --------       -------    --------     -------    --------
                                               33,653       42,409        63,400      19,740       8,857     168,059
                                             --------    ---------      --------    --------    --------   ---------
Interest sensitivity gap..................   $ (4,496)   $(19,126)      $(27,258)   $ 45,737    $ 13,868   $   8,725
                                             ========    ========       ========    ========    ========   =========
                                                                                                      

Cumulative interest sensitivity gap.......   $ (4,496)   $(23,622)      $(50,880)   $ (5,143)   $  8,725
                                             ========    ========       ========    ========    ======== 
Ratio of interest-earning assets to
  interest-bearing liabilities............        .87          .55          .57         3.32        2.57
                                             ========    =========      ========     =======     =======
Cumulative ratio..........................        .87          .69           .64         .97        1.05
                                             ========    =========      ========     =======     =======
                                                
Ratio of cumulative gap to total
  interest-earning assets.................       (.03)        (.13)         (.29)       (.03)        .05
                                             ========    =========      ========     =======     =======
</TABLE>

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

(1)      Excludes nonaccrual loans and securities.
(2)      Excludes matured certificates which have not been redeemed by the
         customer and on which no interest is accruing.
(3)      Demand and savings deposits and other short term borrowings are assumed
         to be subject to movement into other deposit instruments in equal
         amounts during the 0-30 day period, the 31-90 day period, and the
         91-365 day period.

         The above table indicates that in a rising interest rate environment,
the Company's earnings may be adversely affected in the 0-365 day periods where
liabilities will reprice faster than assets. As seen in the preceding table, for
the first 30 days of repricing opportunity there is an excess of
interest-bearing liabilities over earning assets of approximately 4.5 million.
For the first 365 days, interest-bearing liabilities exceed earning assets by
nearly $51 million. During this one year time frame, 83% of all interest-bearing
liabilities will reprice compared to 50.1% of all interest-earning assets.
Changes in the mix of earning assets or supporting liabilities can either
increase or decrease the net interest margin without affecting interest rate
sensitivity. In addition, the interest rate spread between an asset and its
supporting liability can vary significantly while the timing of repricing for
both the asset and the liability remain the same, thus impacting net interest
income. Due to management's continued emphasis on profitability, many of the
higher yielding securities presented in the table above have call features,
which may result


                                       38
<PAGE>   41

in such securities having a shorter effective life. This in turn may reduce the
interest rate sensitivity gap presented above. It should be noted, therefore,
that a matched interest-sensitive position by itself will not ensure maximum net
interest income.

         Management continually evaluates the condition of the economy, the
pattern of market interest rates and other economic data to determine the types
of investments that should be made and at what maturities. Using this analysis,
management from time to time assumes calculated interest sensitivity gap
positions to maximize net interest income based upon anticipated movements in
the general level of interest rates.

Impact of Inflation and Changing Prices

         A bank's asset and liability structure is substantially different from
that of an industrial company in that virtually all assets and liabilities of a
bank are monetary in nature. Management believes the impact of inflation on
financial results depends upon the ability of the Banks to react to changes in
interest rates and by such reaction to reduce the inflationary impact on
performance. Interest rates do not necessarily move in the same direction, or at
the same magnitude, as the prices of other goods and services. As discussed
previously, management seeks to manage the relationship between
interest-sensitive assets and liabilities in order to protect against wide
interest rate fluctuations, including those resulting from inflation.

         Various information shown elsewhere in this Report will assist the
Company in the understanding of how well the Banks are positioned to react to
changing interest rates and inflationary trends. In particular, the summary of
net interest income, the maturity distributions, the composition of the loan and
security portfolios and the data on the interest sensitivity of loans and
deposits should be considered.

Recent Accounting Pronouncements

         The Company has adopted Statement of Financial Accounting Standards No.
130, "Reporting Comprehensive Income." Statement No. 130 establishes standards
for reporting and displaying comprehensive income, as defined therein, and its
components in financial statements issued for the fiscal years beginning after
December 15, 1997. Statement No. 130 requires the inclusion in comprehensive
income of the change in certain previously recognized components of
shareholders's equity. In compliance with Statement No. 130, the Company has
included, as an additional financial statement, Consolidated Statements of
Comprehensive Income for the years ended December 31, 1998, 1997 and 1996. For
the Company, this required the inclusion of unrealized gains (losses) on
investment and available for sale securities, net of taxes, arising during the
respective periods. For the year ended December 31, 1998, the change in
unrealized gains on securities represented an increase in net income, as
reported, by $90,5542 (7.5%), net of tax. For the year ended December 31, 1997,
the change in unrealized gains on securities represented an increase in net
income, as reported, of $42,744 (4.2%), net of tax. For the year ended December
31, 1996, the change in unrealized gains on securities represented a decrease in
net income, as reported, of $75,130 (14.5%), net of tax.

         In June 1997, the Financial Accounting Standards Board (FASB) issued
SFAS No. 131, Disclosures about Segments of an Enterprise and Related
Information, which establishes standards for the way that public business
enterprises report information about operating segments in annual financial
statements and requires that those enterprises report selected information about
operating segments in interim financial reports issued to shareholders. This
statement also establishes standards for related disclosures about products and
services, geographic areas, and major customers. This statement requires the
reporting of financial and descriptive information about an enterprise's
reportable operating segments. This statement is effective for financial
statements for periods beginning after December 15, 1997. All of the Company's
offices offer similar products and services, are located in the same geographic
region, and serve the same customer segments of the market. As a result,
management considers all units as one operating segment and therefore feels that
the basic financial statements and related footnotes provide details related to
segment reporting.

         Effective for years ending after December 15, 1998, SFAS 132,
"Employers Disclosures about Pensions and Other Postretirement Benefits" was
issued by FASB which standardizes the disclosure requirements for 


                                       39
<PAGE>   42

pensions and other postretirement benefits to the extent practicable, requires
additional information on changes in the benefit obligations and fair values of
plan assets that will facilitate financial analysis, and eliminates certain
other disclosures previously required. Management does not believe that the
adoption of SFAS 132 will have a material impact on the Company's consolidated
financial statements.

         In June 1998, the Financial Accounting Standards Board also issued SFAS
No. 133, Accounting for Derivative Instruments and Hedging Activities. This
statement establishes accounting and reporting standards for derivative
instruments and for hedging activities. It requires that an entity recognize all
derivatives as either assets or liabilities in the statement of financial
condition and measure those instruments at fair value. The accounting for
changes in the fair value of a derivative is to be determined based upon the
intended use of the derivative. For certain hedge designations (cash flow and
foreign currency exposure) the derivative's gain or loss is reported as a
component of other comprehensive income. Other designations require the gain or
loss to be recognized in earnings in the period of change. This statement is
effective for financial statements for periods beginning after June 15, 1999.
Management does not believe that the adoption of SFAS No. 133 will have a
material impact on the Company's consolidated financial statements.

Conclusion

         The Company, principally through Gilmer County Bank, has experienced
continued growth since it acquired Gilmer County Bank in July 1996.
Additionally, the Company recently acquired First National. While management
remains optimistic about the prospects for continued growth and profitability of
the Company and the Banks, management does not anticipate that such growth will
be at the level experienced during its initial years of operation. No assurance
can be given that the Company or the Banks will continue to grow and be
profitable.

         The foregoing is a forward-looking statement which reflects significant
assumptions and subjective judgments believed by management to be reasonable as
of the date of this Report. It does not constitute a forecast or prediction of
actual results, and actual performance and financial results may differ
materially from those anticipated due to a variety of factors, including but not
limited to those discussed in the section entitled "Cautionary Notice Regarding
Forward-Looking Information" appearing at the beginning of this Report.


Item 7.  Financial Statements

         The consolidated financial statements of the Company, including notes
thereto, and the report of independent auditors are included in this Report
beginning at page F-1 and are incorporated herein by reference.


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

         During the Company's two most recent fiscal years, there has been no
change in the Company's independent accountants or any disagreement with its
accountants on any matter of accounting principles or practices or financial
statement disclosure.

                                       40
<PAGE>   43

                                    PART III

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

         The information appearing under the heading "Election of Directors" and
the subheadings "Executive Officers" and "Section 16(a) Beneficial Ownership
Reporting Compliance" in the Proxy Statement (the "1999 Proxy Statement")
relating to the annual meeting of shareholders of the Company, scheduled to be
held on May 25, 1999, is incorporated herein by reference.

Item 10.   Executive Compensation

         The information appearing under the heading "Compensation of Executive
Officers and Directors" in the 1999 Proxy Statement is incorporated herein by
reference.

Item 11.   Security Ownership of Certain Beneficial Owners and Management

         The information appearing under the heading "Outstanding Voting
Securities of the Company and Principal Holders Thereof" in the 1999 Proxy
Statement is incorporated herein by reference.

Item 12.   Certain Relationships and Related Transactions

         The information appearing under the caption "Certain Relationships and
Transactions" in the 1999 Proxy Statement is incorporated herein by reference.


                                     PART IV

Item 13.   Exhibits and Reports on Form 8-K

           (a)      The following exhibits are filed with this Report:

<TABLE>
<CAPTION>

Exhibit Number                                          Description of Exhibit
--------------                                          ----------------------
<S>                 <C>    
     2.1            Purchase Sale and Assumption Agreement, dated July 10, 1998, by and between Century
                    South Banks, Inc. and the Company  (included as Exhibit 2.1 to the Current Report on
                    Form 8-K of the Company, dated November 30, 1998 (File No. 000-21383), previously
                    filed with the Commission and incorporated herein by reference).

     3.1            Articles of Incorporation of the Company (included as Exhibit 3.1 to the Company's
                    Registration Statement on Form 8-A, dated September 16, 1996 (File No. 000-21383),
                    previously filed with the Commission and incorporated herein by reference).

     3.2            Bylaws of the Company (included as Exhibit 3.2 to the Company's Registration Statement
                    on Form 8-A, dated September 16, 1996 (File No. 000-21383), previously filed with the
                    Commission and incorporated herein by reference).

     4.1            Registration Rights Agreement, dated November 30, 1998, by and among the Company and
                    Community Financial Services, Inc.
</TABLE>


                                       41
<PAGE>   44

<TABLE>
   <S>        <C>    
   4.2        Registration Rights Agreement, dated November 30, 1998, by and among the Company and
              Ellijay Telephone Company, Inc.

   4.3        Registration Rights Agreement, dated November 30, 1998, by and among the Company and
              JBC Bancshares, Inc.

   10.1       1997 Directors' Non-Qualified Stock Option Plan (included as Exhibit 10.1 to the
              Company's Annual Report on Form 10-KSB for the fiscal year ended December 31, 1996
              (File No. 000-21383) and incorporated herein by reference).*

   10.2       1997 Employee Incentive Stock Incentive Plan (included as Exhibit 10.2 to the
              Company's Annual Report on Form  10-KSB for the fiscal year ended December 31, 1996
              (File No. 000-21383) and incorporated herein by reference).*

   10.3       Adoption Agreement for the Appalachian Bancshares, Inc. Section 401(k) Profit Sharing 
              Plan (filed as Exhibit 4.3(a) to the Company's Registration Statement on Form S-8
              (No. 333-27127) and incorporated herein by reference).

   10.4       Georgia Bankers Association Master 401(k) Profit Sharing Plan (filed as Exhibit 4.3(b)
              to the Company's Registration Statement on Form S-8 (No. 333-27127) and incorporated
              herein by reference).

   10.5       First Amendment to the Georgia Bankers Association Master Section 401(k) Profit
              Sharing Plan (filed as Exhibit 4.3(c) to the Company's Registration Statement on Form
              S-8 (No. 333-27127) and incorporated herein by reference).

   10.6       Form of Deferred Fee Agreement between Gilmer County Bank and certain directors and
              executive officers, with addendum (filed as Exhibit 10.6 to the Company's Quarterly
              Report on Form 10-QSB for the period ended June 30, 1997 (File No. 000-21383) and
              incorporated herein by reference).

   10.7       Loan and Stock Pledge Agreement, dated as of November 30, 1998, between the Company
              and The Bankers Bank.

   10.8       Promissory Note, dated November 30, 1998, issued by the Company to The Bankers Bank.

   11         Statement re: Computation of Per Share Earnings

   21         Subsidiaries of the Registrant

   23         Consent of Independent Auditors

   27         Financial Data Schedule

   99         Information required by Form 11-K with respect to the Appalachian Bancshares, Inc.
              Section 401(k) profit Sharing Plan will be filed as an amendment to this Form 10-KSB
              within 180 days after the end of the fiscal year of the plan as permitted by Rule
              15d-21 under the Securities Exchange Act of 1934.

  *  The referenced exhibit is a compensatory contract, plan or arrangement.
</TABLE>

         (b) On December 15, 1998, the Company filed a report on Form 8-K with
respect to the consummation of its acquisition of First National Bank of Union
County reporting information under Items 2 and 7. On February 12, 1999, the
Company filed an amendment to a report on Form 8-K/A with respect to the
consummation of its acquisition of First National Bank of Union County reporting
information under Item 7.





















                                       42
<PAGE>   45


                                   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.

                                             APPALACHIAN BANCSHARES, INC.


                                             By:      /s/  Tracy R. Newton
                                                --------------------------------
                                                      Tracy R. Newton, President
Date:    March 30, 1999

         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 in the capacities and on the dates indicated.

<TABLE>
<S>                                                                    <C> 

         /s/  Tracy R. Newton                                          Date: March 30, 1999
--------------------------------------------
Tracy R. Newton, President, Chief
  Executive Officer and Director
  [Principal Executive Officer]

         /s/  Kent W. Sanford                                          Date: March 30, 1999
--------------------------------------------
Kent W. Sanford, Executive Vice President,
  Chief Financial Officer and Chief Operating Officer
  [Principal Financial and Accounting Officer]

         /s/  Alan S. Dover                                            Date: March 30, 1999
--------------------------------------------
Alan S. Dover, Director

         /s/  Charles A. Edmondson                                     Date: March 30, 1999
--------------------------------------------
Charles A. Edmondson, Director

         /s/  Roger E. Futch                                           Date: March 30, 1999
--------------------------------------------
Roger E. Futch, Director

         /s/  Joseph C. Hensley                                        Date: March 30, 1999
--------------------------------------------
Joseph C. Hensley, Director

         /s/  Frank E. Jones                                           Date: March 30, 1999
--------------------------------------------
Frank E. Jones, Director

         /s/  J. Ronald Knight                                         Date: March 30, 1999
--------------------------------------------
J. Ronald Knight, Director

         /s/  P. Joe Sisson                                            Date: March 30, 1999
--------------------------------------------
P. Joe Sisson, Director

         /s/  Kenneth D. Warren                                        Date: March 30, 1999
--------------------------------------------
Kenneth D. Warren, Director
</TABLE>


                                       43
<PAGE>   46

                    MANAGEMENT'S STATEMENT OF RESPONSIBILITY
                            FOR FINANCIAL INFORMATION

                  Appalachian Bancshares, Inc. and Subsidiaries

The management of Appalachian Bancshares, Inc. and Subsidiaries (the " Company")
is responsible for the preparation, integrity, and objectivity of the financial
statements, related financial data, and other information in this annual report.
The financial statements are prepared in accordance with generally accepted
accounting principles and include amounts based on management's best estimates
and judgment where appropriate. Financial information appearing throughout this
annual report is consistent with the financial statements.

In meeting its responsibility both for the integrity and fairness of these
statements and information, management depends on the accounting systems and
related internal accounting controls that are designed to provide reasonable
assurances that (i) transactions are authorized and recorded in accordance with
established procedures, (ii) assets are safeguarded, and (iii) proper and
reliable records are maintained.

The concept of reasonable assurance is based on the recognition that the cost of
internal control systems should not exceed the related benefits. As an integral
part of internal control systems, the Company maintains a professional staff of
internal auditors who monitor compliance and assess the effectiveness of
internal control systems and coordinate audit coverage with independent
certified public accountants.

The responsibility of the Company's independent certified public accountants is
limited to an expression of their opinion as to the fairness of the financial
statements presented. Their opinion is based on an audit conducted in accordance
with generally accepted auditing standards as described in their report.

The board of directors is responsible for insuring that both management and the
independent certified public accountants fulfill their respective
responsibilities with regard to the financial statements. The Audit Committee
meets periodically with both management and the independent certified public
accountants to assure that each is carrying out its responsibilities. The
independent certified public accountants have full and free access to the Audit
Committee and board of directors and may meet with them, with and without
management being present, to discuss auditing and financial reporting matters.


                                      F-1

<PAGE>   47


                  APPALACHIAN BANCSHARES, INC. AND SUBSIDIARIES


                   INDEX TO CONSOLIDATED FINANCIAL STATEMENTS



<TABLE>
<CAPTION>
                                                                                                              Page(s)
                                                                                                              -------
<S>                                                                                                           <C>
Independent Auditors' Report................................................................................    F-3

Consolidated Statements of Financial Condition as of December 31, 1998 and 1997.............................    F-4

Consolidated Statements of Income for the years ended
  December 31, 1998, 1997 and 1996..........................................................................    F-5

Consolidated Statements of Shareholders' Equity for the Years Ended
  December 31, 1998, 1997 and 1996..........................................................................    F-6

Consolidated Statements of Cash Flows for the Years Ended
  December 31, 1998, 1997 and 1996..........................................................................    F-7

Consolidated Statements of Comprehensive Income for the Years Ended
December 31, 1998, 1997 and 1996............................................................................    F-8

Notes to Consolidated Financial Statements..................................................................    F-9
</TABLE>


                        SCHAUER, TAYLOR, COX & VISE, P.C.



                                      F-2
<PAGE>   48
                       SCHAUER, TAYLOR, COX & VISE, P.C.



                  CERTIFIED PUBLIC ACCOUNTANTS AND CONSULTANTS
                               150 OLDE TOWNE ROAD
                            BIRMINGHAM, ALABAMA 35216


DOUGLAS B. SCHAUER, CPA      TELEPHONE (205) 822-3488   STEVEN W. BROWN, CPA
EDWARD R. TAYLOR, CPA        WATS (800) 466-3488        M. BRYANT KING, CPA
W. ERNEST COX, CPA            FAX (205) 822-3541        RAYMOND A. PATTON, CPA
DONALD G. VISE, CPA                                     RUSSELL D. PAYNE, CPA
                                                        MICHAEL WHITEHURST, CBA


                          INDEPENDENT AUDITOR'S REPORT


To the Board of Directors and Shareholders
of Appalachian Bancshares, Inc. and Subsidiaries

We have audited the accompanying consolidated statements of financial condition
of Appalachian Bancshares, Inc. and Subsidiaries as of December 31, 1998 and
1997, and the related consolidated statements of income, shareholders' equity,
cash flows, and comprehensive income for each of the three years in the period
ended December 31, 1998. These financial statements are the responsibility of
the Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.

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

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



Birmingham, Alabama
February 5, 1999

                                        /s/ Schauer, Taylor, Cox & Vise, P.C.

                                       SCHAUER, TAYLOR, COX & VISE, P.C.

AMERICAN INSTITUTE OF CPAS                            ALABAMA SOCIETY OF CPA'S


                                      F-3
<PAGE>   49


                 CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
                  APPALACHIAN BANCSHARES, INC. AND SUBSIDIARIES
                           DECEMBER 31, 1998 AND 1997


<TABLE>
<CAPTION>
                                                                                          1998              1997      
                                                                                    ---------------    ---------------
<S>                                                                                 <C>                <C>            
ASSETS
   Cash and due from banks......................................................    $     5,481,853    $     3,383,533
   Interest-bearing deposits with other banks...................................            407,229                -0-
   Federal funds sold...........................................................         18,392,213          1,828,000

   Securities available for sale................................................         21,940,281         15,544,585
   Securities held-to-maturity, estimated fair value of $6,457,522
     and $4,308,947, respectively...............................................          6,218,354          4,181,021

   Loans, net of unearned income................................................        129,831,095         84,583,853
   Allowance for loan losses....................................................         (1,686,395)          (929,590)
                                                                                    ---------------    ---------------
       NET LOANS................................................................        128,144,700         83,654,263

   Premises and equipment, net..................................................          3,940,032          1,653,043
   Accrued interest.............................................................          1,319,601            971,550
   Cash surrender value on life insurance.......................................            615,438            585,615
   Intangible, net..............................................................          2,345,055                -0-
   Other assets.................................................................            940,194            379,180
                                                                                    ---------------    ---------------
       TOTAL ASSETS.............................................................    $   189,744,950    $   112,180,790
                                                                                    ===============    ===============

LIABILITIES AND SHAREHOLDERS' EQUITY
LIABILITIES
   Deposits:
     Noninterest-bearing........................................................    $     9,287,933    $     3,800,911
     Interest-bearing...........................................................        154,573,545         91,547,035
                                                                                    ---------------    ---------------
       TOTAL DEPOSITS...........................................................        163,861,478         95,347,946
   Securities sold under agreements to repurchase...............................          2,478,344          4,228,129
   Accrued interest.............................................................            665,883            188,230
   Long-term debt...............................................................         11,007,143          5,320,000
   Other liabilities............................................................            252,408            116,432
                                                                                    ---------------    ---------------
       TOTAL LIABILITIES........................................................        178,265,256        105,200,737
                                                                                    ---------------    ---------------
SHAREHOLDERS' EQUITY
   Common stock, par value $5 per share, 20,000,000 shares authorized,
     1,367,188 and 1,184,574 shares issued, respectively........................          6,835,940          5,922,870
   Treasury stock, 44,000 and 30,000 shares at cost.............................           (428,000)          (274,000)
   Capital surplus..............................................................          2,576,849            135,051
   Retained earnings............................................................          2,394,590          1,186,359
   Accumulated comprehensive income: net unrealized holding
     gains on securities available-for-sale, net of deferred income tax.........            100,315              9,773
                                                                                    ---------------    ---------------
       TOTAL SHAREHOLDERS' EQUITY...............................................         11,479,694          6,980,053
                                                                                    ---------------    ---------------

TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY......................................    $   189,744,950    $   112,180,790
                                                                                    ===============    ===============
</TABLE>

                 See notes to consolidated financial statements

                                      F-4

<PAGE>   50


                        CONSOLIDATED STATEMENTS OF INCOME

                  APPALACHIAN BANCSHARES, INC. AND SUBSIDIARIES
                  YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996


<TABLE>
<CAPTION>
                                                                       1998               1997              1996      
                                                                 ----------------   ---------------    ---------------
<S>                                                              <C>                <C>                <C>            
INTEREST INCOME
   Interest and fees on loans.................................   $      9,614,165   $     7,652,481    $     5,205,131
   Interest on investment securities:
     Taxable securities.......................................          1,009,595         1,160,497            977,917
     Nontaxable securities....................................            376,157           170,274             24,228
   Interest on deposits in banks..............................              1,963               -0-                -0-
   Interest on federal funds sold.............................            269,112           159,716            104,021
                                                                 ----------------   ---------------    ---------------
       TOTAL INTEREST INCOME..................................         11,270,992         9,142,968          6,311,297
                                                                 ----------------   ---------------    ---------------

INTEREST EXPENSE
   Interest on deposits.......................................          5,891,798         4,911,266          3,436,060
   Interest on federal funds purchased and securities sold
     under agreements to repurchase...........................            178,437           201,407            219,500
   Interest on long-term debt.................................            427,984           149,580              4,667
                                                                 ----------------   ---------------    ---------------
       TOTAL INTEREST EXPENSE.................................          6,498,219         5,262,253          3,660,227
                                                                 ----------------   ---------------    ---------------

NET INTEREST INCOME...........................................          4,772,773         3,880,715          2,651,070
   Provision for loan losses..................................            300,000           480,000            368,000
                                                                 ----------------   ---------------    ---------------

NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES...........          4,472,773         3,400,715          2,283,070

NONINTEREST INCOME
   Service charges on deposits................................            238,921           197,333            134,642
   Insurance commissions......................................             22,333            20,655             24,355
   Other operating income.....................................            251,717           161,086             85,055
   Investment securities gains (losses).......................             15,950               (78)             8,894
                                                                 ----------------   ---------------    ---------------
       TOTAL NONINTEREST INCOME...............................            528,921           378,996            252,946
                                                                 ----------------   ---------------    ---------------

NONINTEREST EXPENSES
   Salaries and employee benefits.............................          1,496,743         1,154,456            892,992
   Occupancy expense..........................................            173,034            97,267             96,165
   Furniture and equipment expense............................            252,806           150,358            126,439
   Other operating expenses...................................          1,298,630           977,277            599,776
                                                                 ----------------   ---------------    ---------------
       TOTAL NONINTEREST EXPENSES.............................          3,221,213         2,379,358          1,715,372
                                                                 ----------------   ---------------    ---------------

   Income (Loss) before income taxes..........................          1,780,481         1,400,353            820,644
   Income tax (provision) benefit.............................           (572,250)         (382,587)          (303,908)
                                                                 ----------------   ---------------    ---------------

NET INCOME (LOSS).............................................   $      1,208,231   $     1,017,766    $       516,736
                                                                 ================   ===============    ===============

EARNINGS (LOSS) PER COMMON SHARE - BASIC AND DILUTIVE
   Net income (loss) per common share-
     Basic earnings per share.................................   $           1.04   $           .88    $           .45
     Basic weighted average shares outstanding................          1,166,425         1,154,990          1,136,000
     Diluted earnings per share...............................   $           0.99   $           .88    $           .45
     Diluted weighted average shares outstanding..............          1,220,976         1,162,206          1,136,000
</TABLE>


                 See notes to consolidated financial statements


                                      F-5
<PAGE>   51


                 CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
                  APPALACHIAN BANCSHARES, INC. AND SUBSIDIARIES
                  YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996


<TABLE>
<CAPTION>
                                                                                                ACCUMULATED
                                           COMMON    TREASURY       CAPITAL        RETAINED    COMPREHENSIVE
                                           STOCK      STOCK         SURPLUS        EARNINGS        INCOME          TOTAL
                                       ----------   ----------  ------------   -------------   -------------    --------------
<S>                                    <C>          <C>             <C>          <C>            <C>             <C>           
Balance at January 1, 1996........     $2,840,000   $     -0-   $  2,829,314   $    (348,143)   $     42,159    $    5,363,330

Two-for-one stock split...........      2,840,000                 (2,840,000)                                              -0-
                                       ----------   ----------  ------------   -------------   -------------    --------------

Restated beginning balance........      5,680,000                    (10,686)       (348,143)         42,159         5,363,330

Net Change in Unrealized Gains
   (Losses) on Securities.........            -0-          -0-           -0-             -0-         (75,130)          (75,130)
Net Income 1996...................            -0-          -0-           -0-         516,736             -0-           516,736
                                       ----------    ---------  ------------   -------------    ------------    --------------

Balance at December 31, 1996......      5,680,000          -0-       (10,686)        168,593         (32,971)        5,804,936

Proceeds from sale of common                         
   stock to 401(k) plan...........        242,870          -0-       145,737             -0-             -0-           388,607
Purchase of Treasury Stock........            -0-     (274,000)          -0-             -0-             -0-          (274,000)
Net Change in Unrealized Gains
   on Securities..................            -0-          -0-           -0-             -0-          42,744            42,744
Net Income 1997...................            -0-          -0-           -0-       1,017,766             -0-         1,017,766
                                       ----------    ---------   -----------   -------------    ------------     -------------

BALANCE AT DECEMBER 31, 1997...         5,922,870     (274,000)      135,051       1,186,359           9,773         6,980,053

PROCEEDS FROM SALE OF COMMON
   STOCK TO 401(K) PLAN...........         96,570                    214,058             -0-             -0-           310,628
PURCHASE OF TREASURY STOCK........            -0-     (154,000)          -0-             -0-             -0-          (154,000)
NET CHANGE IN UNREALIZED GAINS
   ON SECURITIES..................            -0-          -0-           -0-             -0-          71,614            71,614
PROCEEDS FROM EXERCISE
   OF OPTIONS.....................        154,000          -0-       240,240             -0-             -0-           394,240
PRIVATE PLACEMENT SALE OF STOCK...        662,500          -0-     1,987,500             -0-             -0-         2,650,000
EFFECT OF BUSINESS COMBINATION....            -0-          -0-           -0-             -0-          18,928            18,928
NET INCOME 1998...................            -0-          -0-           -0-       1,208,231             -0-         1,208,231
                                       ---------    ----------   -----------   -------------    ------------    --------------

BALANCE AT DECEMBER 31, 1998...        $6,835,940   $ (428,000) $  2,576,849   $   2,394,590    $    100,315    $   11,479,694
                                       ==========   ==========  ============   =============    ============    ==============
</TABLE>

                 See notes to consolidated financial statements

                                      F-6
<PAGE>   52



                      CONSOLIDATED STATEMENTS OF CASH FLOWS
                  APPALACHIAN BANCSHARES, INC. AND SUBSIDIARIES
                   YEAR ENDED DECEMBER 31, 1998, 1997 AND 1996

<TABLE>
<CAPTION>
                                                                1998            1997            1996      
                                                            ------------    ------------    ------------
<S>                                                          <C>             <C>             <C>         
OPERATING ACTIVITIES
   Net income ............................................   $  1,208,231    $  1,017,766    $    516,736
   Adjustments to reconcile net income to net cash
     provided by operating activities:
     Depreciation, amortization, and accretion, net ......        188,653         165,242         127,620
     Provision for loan losses ...........................        300,000         480,000         368,000
     Deferred tax (benefit) ..............................            -0-         (73,426)         (8,622)
     Realized security (gains) losses, net ...............        (15,950)             78          (8,894)
     Losses on disposition of foreclosed real estate .....            -0-           3,927             -0-
     Increase in cash surrender value on life insurance ..        (29,823)        (17,215)            -0-
     Increase in accrued interest receivable .............       (122,861)       (164,739)       (414,018)
     Increase in accrued interest payable ................         46,854          33,769          59,109
     Other ...............................................       (301,959)         19,186         (28,100)
                                                             ------------    ------------    ------------
       NET CASH PROVIDED BY OPERATING ACTIVITIES .........   $  1,273,145    $  1,464,588    $    611,831
                                                             ------------    ------------    ------------

INVESTING ACTIVITIES
   Proceeds from sales of securities available for sale ..      9,515,761       9,982,814       4,497,500
   Proceeds from maturity of securities available for sale     11,597,023       8,513,974       4,531,902
   Proceeds from maturity of securities held-to-maturity .            594         145,000             -0-
   Purchase of securities available for sale .............    (23,834,942)    (13,991,323)    (15,208,797)
   Purchase of securities held-to-maturity ...............     (1,091,138)     (1,939,327)     (2,247,479)
   Net increase in loans to customers ....................    (21,786,395)    (19,827,817)    (32,830,349)
   Capital expenditures, net .............................       (548,857)       (121,199)       (118,918)
   Proceeds from disposition of foreclosed real estate ...        113,500
   Purchase of life insurance plan .......................            -0-        (568,400)            -0-
   Cash received in bank acquisition, net ................     10,721,749             -0-             -0-
                                                             ------------    ------------    ------------
       NET CASH USED IN INVESTING ACTIVITIES .............    (15,312,705)    (17,806,278)    (41,376,141)
                                                             ------------    ------------    ------------

FINANCING ACTIVITIES
   Net increase in demand deposits, NOW accounts,
     and savings accounts ................................     19,557,448      11,384,300      16,452,274
   Net increase in certificates of deposit ...............      6,413,648       2,815,766      22,554,275
   Net increase (decrease) in securities sold
     under agreement to repurchase .......................     (1,749,785)     (1,055,843)        972,056
   Issuance of long-term debt ............................      7,007,143       4,620,000         700,000
   Repayment of long-term debt ...........................     (1,320,000)            -0-             -0-
   Issuance of common stock ..............................      3,354,868         388,607             -0-
   Purchase of treasury stock ............................       (154,000)       (274,000)            -0-
                                                             ------------    ------------    ------------
       NET CASH PROVIDED BY FINANCING ACTIVITIES .........     33,109,322      17,878,830      40,678,605
                                                             ------------    ------------    ------------

Net increase in cash and cash equivalents ................     19,069,762       1,537,140         (85,705)

Cash and cash equivalents at beginning of year ...........      5,211,533       3,674,393       3,760,098
                                                             ------------    ------------    ------------

CASH AND CASH EQUIVALENTS AT END OF YEAR .................   $ 24,281,295    $  5,211,533    $  3,674,393
                                                             ============    ============    ============
</TABLE>


                                      F-7


<PAGE>   53

<TABLE>
<CAPTION>


                                                                1998        1997          1996      
                                                            ------------  ----------   -----------
<S>                                                         <C>           <C>           <C>        
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Cash Paid during the year for:
     Interest ...........................................   $ 6,451,365   $5,228,484   $ 3,601,118
     Income taxes .......................................       632,799      435,511       301,983

   Loans transferred to foreclose real estate ...........       223,056      109,209        59,275

   Net increase (decrease) in unrealized gains and losses
     on securities available for sale ...................       108,620       64,762      (114,114)

   Proceeds from sales of foreclosed real estate financed
     through loans ......................................       109,556      105,282        54,170

   Assets acquired in business combination ..............    29,977,439          -0-           -0-

   Liabilities assumed in business combination ..........    43,035,046          -0-           -0-
</TABLE>


                 See notes to consolidated financial statements



                                      F-8



<PAGE>   54


                 CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

                  APPALACHIAN BANCSHARES, INC. AND SUBSIDIARIES
                  YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996



<TABLE>
<CAPTION>

                                                                            1998             1997            1996     
                                                                        -------------   -------------    -------------
<S>                                                                     <C>             <C>              <C>          
NET INCOME...........................................................   $   1,208,231   $   1,017,766    $     516,736

Other comprehensive income, net of tax:
   Unrealized gains on securities
     Unrealized holding gains (losses) arising during period.........         155,080          64,684         (104,939)
     Reclassified adjustments for (gains) losses
       included in net income........................................         (15,950)             78           (8,894)
                                                                        -------------   -------------    -------------
     Net unrealized gains (losses)...................................         139,130          64,762         (113,833)
   Income tax related to items of other comprehensive income.........         (48,588)        (22,018)          38,703
                                                                        -------------   -------------    -------------
Other comprehensive income...........................................          90,542          42,744          (75,130)
                                                                        -------------   -------------    -------------

COMPREHENSIVE INCOME.................................................   $   1,298,773   $   1,060,510    $     441,606
                                                                        =============   =============    =============

</TABLE>

                 See notes to consolidated financial statements


                                      F-9
<PAGE>   55


                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                  APPALACHIAN BANCSHARES, INC. AND SUBSIDIARIES

                        DECEMBER 31, 1998, 1997 AND 1996



NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

The accompanying consolidated financial statements include the accounts of
Appalachian Bancshares, Inc. and its wholly owned subsidiaries: Gilmer County
Bank ("GCB") and First National Bank of Union County ("FNB") (referred to herein
collectively as the "Banks"). Prior to August 1996, Gilmer County Bank operated
as an independent bank. Prior to November 1998, First National Bank of Union
County operated as a wholly-owned subsidiary bank of Century South Banks, Inc.
The Company was formed in May 1996 for the purpose of acquiring all the
outstanding stock of Gilmer County Bank, and operating as a bank holding
company. The acquisition of GCB was accounted for as a pooling of interests. The
acquisition of FNB was accounted for as a purchase. These entities are
collectively referred to herein as the Company. All significant intercompany
transactions and balances have been eliminated in consolidation. Unless
otherwise indicated herein, the financial results of the Company refer to the
Company and the Banks on a consolidated basis. The Banks provide a full range of
banking services to individual and corporate customers in North Georgia and the
surrounding areas.

Consolidated Statements of Comprehensive Income

The company adopted Statement of Financial Accounting Standards (SFAS) No. 130,
Reporting Comprehensive Income, on December 31, 1998. This statement establishes
standards for the reporting and display of comprehensive income and its
components in a full set of general-purpose financial statements. The statement
requires that an enterprise classify items of other comprehensive income by
their nature in the financial statement and display the accumulated balance of
other comprehensive income separately from retained earnings and additional paid
in capital in the equity section of a statement of financial condition.
Comprehensive income is generally defined as the change in equity of a business
enterprise during a period from transactions and other events and circumstances
from non-owner sources. It includes all changes in equity during a period except
those resulting from investments by owners and distributions to owners.

Use of Estimates

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

Securities

Securities are classified as either held-to-maturity, available-for-sale, or
trading.

Held-to-maturity securities are securities for which management has the ability
and intent to hold on a long-term basis or until maturity. These securities are
carried at amortized cost, adjusted for amortization of premiums, and accretion
of discount to the earlier of the maturity or call date.

Securities available-for-sale represent those securities intended to be held for
an indefinite period of time, including securities that management intends to
use as part of its asset/liability strategy, or that may be sold in response to
changes in interest rates, changes in prepayment risk, the need to increase
regulatory capital, or other similar factors. Securities available-for-sale are
recorded at market value with unrealized gains and losses net of any tax effect,
added or deducted directly from shareholders' equity.

                                      F-10
<PAGE>   56
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                  APPALACHIAN BANCSHARES, INC. AND SUBSIDIARIES

                        DECEMBER 31, 1998, 1997 AND 1996



NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - CONTINUED

Securities carried in trading accounts are carried at market value with
unrealized gains and losses reflected in income.

Realized and unrealized gains and losses are based on the specific
identification method.

Declines in the fair value of individual held-to maturity and available-for-sale
securities below their cost that are other than temporary result in write-downs
of the individual securities to their fair value. The related write-downs are
included in earnings as realized losses.

The Company has no trading securities.

Loans

Loans are stated at unpaid principal balances, less the allowance for loan
losses, net deferred loan fees and unearned discounts.

Unearned discounts on installment loans are recognized as income over the term
of the loans using a method that approximates the interest method.

Loan origination and commitment fees, as well as certain origination costs, when
material, are deferred and amortized as a yield adjustment over the lives of the
related loans using the interest method.

Allowance for Possible Loan Losses

A loan is considered impaired, based on current information and events, if it is
probable that the Company will be unable to collect the scheduled payments of
principal or interest when due according to the contractual terms of the loan
agreement. Uncollateralized loans are measured for impairment based on the
present value of expected future cash flows discounted at the historical
effective interest rate, while all collateral-dependent loans are measured for
impairment based on the fair value of the collateral. Smaller balance
homogeneous loans which consist of residential mortgages and consumer loans are
evaluated collectively and reserves are established based on historical loss
experience.

The allowance for loan losses is established through charges to earnings in the
form of a provision for loan losses. Increases and decreases in the allowance
due to changes in the measurement of the impaired loans are included in the
provision for loan losses. Loans continue to be classified as impaired unless
they are brought fully current and the collection of scheduled interest and
principal is considered probable. When a loan or portion of a loan is determined
to be uncollectible, the portion deemed uncollectible is charged against the
allowance and subsequent recoveries, if any, are credited to the allowance.

Management's periodic evaluation of the adequacy of the allowance is based on
the Banks' past loan loss experience, known and inherent risks in the portfolio,
adverse situations that may affect the borrowers' ability to repay, estimated
value of any underlying collateral, and an analysis of current economic
conditions. While management believes that it has established the allowance in
accordance with generally accepted accounting principles and has taken into
account the views of its regulators and the current economic environment; there
can be no assurance that in the future the Banks' regulators or its economic
environment will not require further increases in the allowance.



                                      F-11
<PAGE>   57


                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                  APPALACHIAN BANCSHARES, INC. AND SUBSIDIARIES

                        DECEMBER 31, 1998, 1997 AND 1996



NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - CONTINUED

Income Recognition on Impaired and Nonaccrual Loans

Loans, including impaired loans, are generally classified as nonaccrual if they
are past due as to maturity or payment of principal or interest for a period of
more than 90 days, unless such loans are well collateralized and in the process
of collection. If a loan or a portion of a loan is classified as doubtful or is
partially charged off, the loan is generally classified as nonaccrual. Loans
that are on a current payment status or past due less than 90 days may also be
classified as nonaccrual if repayment in full of principal and/or interest is in
doubt.

Loans may be returned to accrual status when all principal and interest amounts
contractually due are reasonably assured of repayment within an acceptable
period of time, and there is a sustained period of repayment performance by the
borrower, in accordance with the contractual terms of interest and principal.

While a loan is classified as nonaccrual and the future collectability of the
recorded loan balance is doubtful, collections of interest and principal are
generally applied as a reduction to principal outstanding, except in the case of
loans with scheduled amortizations where the payment is generally applied to the
oldest payment due. When the future collectability of the recorded loan balance
is expected, interest income may be recognized on a cash basis. In the case
where a nonaccrual loan has been partially charged off, recognition of interest
on a cash basis is limited to that which would have been recognized on the
recorded loan balance at the contractual interest rate. Receipts in excess of
that amount are recorded as recoveries to the allowance for loan losses until
prior charge offs have been fully recovered. Interest income recognized on a
cash basis was immaterial for the years ended December 31, 1998, 1997, and 1996.

Premises and Equipment

Land is carried at cost. Other premises and equipment are carried at cost net of
accumulated depreciation. Depreciation is computed using the straight-line and
the declining balance methods based principally on the estimated useful lives of
the assets. Maintenance and repairs are expended as incurred while major
additions and improvements are capitalized. Gains and losses on dispositions are
included in current operations.

Foreclosed Real Estate

Foreclosed real estate includes both formally foreclosed property and
in-substance foreclosed property. In-substance foreclosed properties are those
properties for which the institution has taken physical possession, regardless
of whether formal foreclosure proceedings have taken place.

At the time of foreclosure, foreclosed real estate is recorded at the lower of
the carrying amount or fair value less cost to sell, which becomes the
property's new basis. Any write-downs based on the asset's fair value at date of
acquisition are charged to the allowance for loan losses. After foreclosure,
these assets are carried at the lower of their new cost basis or fair value less
cost to sell.

Costs incurred in maintaining foreclosed real estate and subsequent adjustments
to the carrying amount of the property are included in income (loss) on
foreclosed real estate.



                                      F-12
<PAGE>   58
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                  APPALACHIAN BANCSHARES, INC. AND SUBSIDIARIES

                        DECEMBER 31, 1998, 1997 AND 1996


NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - CONTINUED

Income Taxes

Income taxes are provided for the tax effects of the transactions reported in
the financial statements and consist of taxes currently due plus deferred taxes
related primarily to differences between the basis of the allowance for loan
losses and accumulated depreciation. The deferred tax assets and liabilities
represent the future tax return consequences of those differences, which will
either be taxable or deductible when the assets and liabilities are recovered or
settled. Deferred tax assets and liabilities are reflected at income tax rates
applicable to the period in which the deferred tax assets or liabilities are
expected to be realized or settled. As changes in tax laws or rates are enacted,
deferred tax assets and liabilities are adjusted through the provision for
income taxes. The Company files consolidated income tax returns with its
subsidiaries.

Earnings per Common Share

The Company adopted SFAS No. 128, Earnings Per Share, on December 31, 1997. This
statement establishes standards for computing and presenting earnings per share
("EPS") and applies to entities with publicly held common stock or potential
common stock. This statement replaces the presentation of primary EPS with a
presentation of basic EPS and requires dual presentation of basic and diluted
EPS on the face of the income statement for all entities with complex capital
structures and requires a reconciliation of the numerator and denominator of the
basic EPS computation to the numerator and denominator of the diluted EPS
computation. All prior year earnings per share data have been restated to
reflect the presentation required under SFAS No. 128.

<TABLE>
<CAPTION>
                                                                                   1998          1997          1996
                                                                                ----------   -----------    ---------
<S>                                                                              <C>           <C>           <C>      
Weighted average of common shares outstanding...............................     1,166,425     1,154,990     1,136,000
Effect of dilutive options..................................................        54,551         7,216           -0-
                                                                                ----------   -----------   -----------
Weighted average of common shares outstanding effected for dilution.........     1,220,976     1,162,206     1,136,000
                                                                                ==========   ===========   ===========
</TABLE>

In May 1998, the Company issued a 2-for-1 stock split. All per share amounts
included in these financial statements have been retroactively adjusted to give
effect to this split.

Stock-Based Compensation

In October 1995, the FASB issued SFAS No. 123, Accounting for Stock-Based
Compensation; which defines a fair value based method of accounting for an
employee stock option plan. This statement establishes financial accounting and
reporting standards for stock-based employee compensation plans and stock-based
non-employee compensation. These transactions must be accounted for based on the
fair value of the consideration received or the fair value of the equity
instruments issued, whichever is more reliably measured. Under the fair value
based method, compensation is measured at the grant date based on the value of
the award and is recognized over the service period, which is usually the
vesting period. However, SFAS No. 123 allows an entity to continue to measure
compensation costs for those plans using the intrinsic value based method of
accounting prescribed by APB Opinion No, 25, Accounting for Stock Issued to
Employees. The adoption of this statement did not have a material effect on the
Company's consolidated financial statements.

                                      F-13
<PAGE>   59

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                  APPALACHIAN BANCSHARES, INC. AND SUBSIDIARIES

                        DECEMBER 31, 1998, 1997 AND 1996



NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - CONTINUED

Employee Benefit Plan

The Company has a 401(k) profit-sharing plan covering substantially all of its
employees. Eligible participating employees may elect to contribute tax-deferred
contributions. Company contributions to the plan are determined by the board of
directors.

Intangibles

Intangibles consist primarily of legal, organizational costs, and goodwill.
Organizational costs are generally amortized over 5 years using the
straight-line method. The goodwill intangible represents a premium paid on the
purchase of assets and deposit liabilities. The asset is stated at cost, net of
accumulated amortization, which is provided using the straight-line method over
the estimated useful life of 20 years.

Off Balance Sheet Financial Instruments

In the ordinary course of business the Company has entered into
off-balance-sheet financial instruments consisting of commitments to extend
credit, commitments under credit card arrangements, commercial letters of credit
and standby letters of credit. Such financial instruments are recorded in the
financial statements when they become payable.

The Company also has available as a source of short-term financing the purchase
of federal funds from other commercial banks from an available line of up to
$4.5 million and a line of credit with the Federal Home Loan Bank of up to $12
million.

Cash Flow Information

For purposes of the statements of cash flows, the company considers cash, due
from banks and federal funds sold as cash and cash equivalents.

Reclassifications

Certain amounts in 1997 and 1996 have been reclassified to conform with the 1998
presentation.

Recently Issued Accounting Standards

In June 1997, the Financial Accounting Standards Board (FASB) issued SFAS No.
131, Disclosures about Segments of an Enterprise and Related Information, which
establishes standards for the way that public business enterprises report
information about operating segments in annual financial statements and requires
that those enterprises report selected information about operating segments in
interim financial reports issued to shareholders. This statement also
establishes standards for related disclosures about products and services,
geographic areas, and major customers. This statement requires the reporting of
financial and descriptive information about an enterprise's reportable operating
segments. This statement is effective for financial statements for periods
beginning after December 15, 1997. All of the Company's offices offer similar
products and services, are located in the same geographic region, and serve the
same customer segments of the market. As a result, management considers all
units as one operating segment and therefore feels that the basic financial
statements and related footnotes provide details related to segment reporting.


                                      F-14
<PAGE>   60

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                  APPALACHIAN BANCSHARES, INC. AND SUBSIDIARIES

                        DECEMBER 31, 1998, 1997 AND 1996



NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - CONTINUED

Effective for years beginning after December 15, 1997, SFAS No. 132, Employers'
Disclosures about Pensions and Other Postretirement Benefits, was issued by FASB
which standardizes the disclosure requirements for pensions and other
postretirement benefits to the extent practicable, requires additional
information on changes in the benefit obligations and fair values of plan assets
that will facilitate financial analysis, and eliminates certain other
disclosures previously required. The adoption of this statement did not have a
material effect on the Company's consolidated financial statements.

In June 1998, the Financial Accounting Standards Board also issued SFAS No. 133,
Accounting for Derivative Instruments and Hedging Activities. This statement
establishes accounting and reporting standards for derivative instruments and
for hedging activities. It requires that an entity recognize all derivatives as
either assets or liabilities in the statement of financial condition and measure
those instruments at fair value. The accounting for changes in the fair value of
a derivative is to be determined based upon the intended use of the derivative.
For certain hedge designations (cash flow and foreign currency exposure) the
derivative's gain or loss is reported as a component of other comprehensive
income. Other designations require the gain or loss to be recognized in earnings
in the period of change. This statement is effective for financial statements
for periods beginning after June 15, 1999. Management does not believe that the
adoption of SFAS No. 133 will have a material impact on the Company's
consolidated financial statements.


NOTE 2 - BUSINESS COMBINATION

On December 1, 1998 the Company purchased First National Bank of Union County, a
wholly-owned subsidiary of Century South Banks, Inc., for $6,100,000. Assets of
approximately $46,789,991 were acquired with approximately $43,035,046 in
liabilities, resulting in a goodwill intangible of approximately $2,345,055.
Amortization of this goodwill is provided on the straight-line basis over a
period of twenty years.

The following is summary operating information for Appalachian Bancshares, Inc.
showing the effect of the business combination described in the preceding
paragraph for the years ended December 31, 1998, 1997, and 1996.


<TABLE>
<CAPTION>
                                                                       As            Effect of         Pro Forma
                                                                     Reported         Purchase           Results    
                                                                   -------------    ------------      -------------
<S>                                                                <C>              <C>               <C>          
AS OF DECEMBER 31, 1998:
   INTEREST INCOME...........................................      $  11,270,992    $   3,430,926     $  14,701,918
   INTEREST EXPENSE..........................................          6,498,219        1,800,728         8,298,947
   NET INTEREST INCOME.......................................          4,772,773        1,630,198         6,402,971
   PROVISION FOR LOAN LOSSES.................................            300,000           31,331           331,331
   NONINTEREST INCOME........................................            528,921          309,282           838,203
   NONINTEREST EXPENSE.......................................          3,221,213        1,628,913         4,850,126
   PROVISION (BENEFIT) FOR INCOME TAXES......................            572,250           69,000           641,250
   NET INCOME (LOSS).........................................          1,208,231          210,236         1,418,467
</TABLE>



                                      F-15
<PAGE>   61

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                  APPALACHIAN BANCSHARES, INC. AND SUBSIDIARIES

                        DECEMBER 31, 1998, 1997 AND 1996


NOTE 2 - BUSINESS COMBINATION - CONTINUED


<TABLE>
<CAPTION>
                                                                         As           Effect of         Pro Forma
                                                                      Reported        Purchase            Results    
                                                                  --------------    -------------      ------------
<S>                                                               <C>               <C>                <C>         
As of December 31, 1997:
   Interest income...........................................     $    9,142,968    $   4,160,221      $ 13,303,189
   Interest expense..........................................          5,262,253        2,002,085         7,264,338
   Net interest income.......................................          3,880,715        2,158,136         6,038,851
   Provision for loan losses.................................            480,000          952,801         1,432,801
   Noninterest income........................................            378,996          360,713           739,709
   Noninterest expense.......................................          2,379,358        1,853,716         4,233,074
   Provision (benefit) for income taxes......................            382,587         (149,000)          233,587
   Net income (loss).........................................          1,017,766         (138,668)          879,098


As of December 31, 1996:
   Interest income...........................................     $    6,311,297    $   4,397,843      $ 10,709,140
   Interest expense..........................................          3,660,227        2,216,646         5,876,873
   Net interest income.......................................          2,651,070        2,181,197         4,832,267
   Provision for loan losses.................................            368,000           66,000           434,000
   Noninterest income........................................            252,946          389,867           642,813
   Noninterest expense.......................................          1,715,372        1,561,153         3,276,525
   Provision (benefit) for income taxes......................            303,908          315,500           619,408
   Net income (loss).........................................            516,736          628,411         1,145,147
</TABLE>


NOTE 3 - RESTRICTIONS ON CASH AND DUE FROM BANK ACCOUNTS

The Company is required to maintain average reserve balances either in vault
cash or on deposit with the Federal Reserve Bank. At December 31, 1998 and 1997,
the average amount of the required reserves was $1,155,000 and $635,000,
respectively.


                                      F-16
<PAGE>   62

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                  APPALACHIAN BANCSHARES, INC. AND SUBSIDIARIES

                        DECEMBER 31, 1998, 1997 AND 1996



NOTE 4 - SECURITIES

The carrying amounts of securities as shown in the consolidated statement of
financial condition of the Company and their approximate fair values at December
31, 1998 and 1997 are presented below.

<TABLE>
<CAPTION>
                                                                              Gross          Gross         Estimated
                                                            Amortized      Unrealized     Unrealized         Fair
                                                              Cost            Gains         Losses           Value    
                                                          -------------  -------------  -------------   --------------
<S>                                                       <C>            <C>            <C>             <C>           
SECURITIES AVAILABLE-FOR-SALE

DECEMBER 31, 1998
   U.S. GOVERNMENT AND AGENCY SECURITIES...............   $  13,581,536  $      72,564  $      11,942   $   13,642,158
   STATE AND MUNICIPAL SECURITIES......................       5,677,978         98,856          1,020        5,775,814
   MORTGAGE BACKED SECURITIES..........................       1,912,831          9,559         14,081        1,908,309
   EQUITY SECURITIES...................................         614,000            -0-            -0-          614,000
                                                          -------------  -------------  -------------   --------------
                                                          $  21,786,345  $     180,979  $      27,043   $   21,940,281
                                                          =============  =============  =============   ==============

December 31, 1997
   U.S. government and agency securities...............   $  13,960,630  $      43,613  $      24,892   $   13,979,351
   Mortgage backed securities..........................       1,169,148            -0-          3,914        1,165,234
   Equity securities...................................         400,000            -0-            -0-          400,000
                                                          -------------  -------------  -------------   --------------

                                                          $  15,529,778  $      43,613  $      28,806   $   15,544,585
                                                          =============  =============  =============   ==============

SECURITIES HELD-TO-MATURITY 

DECEMBER 31, 1998
   STATE AND MUNICIPAL SECURITIES......................   $   6,218,354  $     242,199  $       3,031   $    6,457,522
                                                          =============  =============  =============   ==============

December 31, 1997
   State and municipal securities......................   $   4,181,021  $     128,210  $         284   $    4,308,947
                                                          =============  =============  =============   ==============
</TABLE>

At December 31, 1998, the Company's available-for-sale securities reflected net
unrealized gains of $153,936, which resulted in an increase in stockholders'
equity of $100,315, net of deferred tax liability. At December 31, 1997, the
Company's available-for-sale securities reflected net unrealized gains of
$14,807 which resulted in an increase in stockholders' equity of $9,773, net of
deferred tax liability.

The contractual maturities of securities available-for-sale at December 31, 1998
are shown as follows. Expected maturities will differ from contractual
maturities because borrowers may have the right to call or prepay obligations
with or without call or prepayment penalties.


                                      F-17
<PAGE>   63

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                  APPALACHIAN BANCSHARES, INC. AND SUBSIDIARIES

                        DECEMBER 31, 1998, 1997 AND 1996




NOTE 4 - SECURITIES - CONTINUED

<TABLE>
<CAPTION>
                                                                                       Amortized         Estimated
                                                                                         Cost            Fair Value   
                                                                                    ---------------    ---------------
<S>                                                                                 <C>                <C>            
As of December 31, 1998:

Securities Available-for-Sale:
   Due in one year or less......................................................    $     1,794,684    $     1,801,575
   Due after one year through five years........................................          7,397,640          7,467,540
   Due after five years through ten years.......................................          9,327,219          9,381,651
   Due after ten years..........................................................          2,652,802          2,675,515
   Equity securities............................................................            614,000            614,000
                                                                                    ---------------    ---------------
                                                                                    $    21,786,345    $    21,940,281
                                                                                    ===============    ===============


Securities Held-to-Maturity:
   Due in one year or less......................................................    $       250,000    $       250,290
   Due after one year through five years........................................          1,109,321          1,137,175
   Due after five through ten years.............................................            669,140            715,980
   Due after ten years..........................................................          4,189,893          4,354,077
                                                                                    ---------------    ---------------
                                                                                    $     6,218,354    $     6,457,522
                                                                                    ===============    ===============
</TABLE>

Mortgage-backed securities have been included in the maturity tables based upon
guaranteed payoff date of each security.

Gross realized gains and losses on the sale of securities available-for-sale for
each of the three years in the period ended December 31, 1998 were as follows:

<TABLE>
<CAPTION>
                                                                       1998               1997              1996      
                                                                 ----------------   ---------------    ---------------
<S>                                                              <C>                <C>                <C>            
Gross realized gains..........................................   $         15,956   $         5,757    $         5,626
Gross realized losses.........................................                  6             5,835                825
</TABLE>

There were no net gains on the maturities of securities for 1998 and 1997. Net
gains on the maturities of securities for 1996 amounted to $4,093.

Other securities include a restricted investment in Federal Home Loan Bank
stock, which must be maintained to secure the available lines of credit. The
amount of investment in this stock amounted to $554,000 and $400,000 at December
31, 1998 and 1997, respectively.

The carrying value of investment securities pledged to secure public funds on
deposit, securities sold under agreements to repurchase, and for other purposes
as required by law amounted to approximately $12,552,000 and $6,606,000 at
December 31, 1998 and 1997.


                                      F-18
<PAGE>   64

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                  APPALACHIAN BANCSHARES, INC. AND SUBSIDIARIES

                        DECEMBER 31, 1998, 1997 AND 1996


NOTE 5 - LOANS

The Company grants loans to customers primarily in the North Georgia area. The
major classifications of loans as of December 31 were as follows:

<TABLE>
<CAPTION>
                                                                                          1998              1997      
                                                                                    ---------------    ---------------
<S>                                                                                 <C>                <C>            
Commercial, financial and agricultural..........................................    $    26,883,464    $    16,535,602
Real estate - construction......................................................          8,542,640          5,118,961
Real estate - mortgage..........................................................         78,965,161         50,928,334
Consumer........................................................................         13,742,818         10,835,331
Other loans.....................................................................          1,697,012          1,165,625
                                                                                    ---------------    ---------------
                                                                                        129,831,095         84,583,853
Allowance for loan losses.......................................................         (1,686,395)          (929,590)
                                                                                    ---------------    ---------------

Net loans.......................................................................    $   128,144,700    $    83,654,263
                                                                                    ===============    ===============
</TABLE>

Total loans which the Company considered to be impaired at December 31, 1998 and
1997, were $4,000 and $15,000, respectively. All of these loans were on
nonaccrual status and had related allowances of $1,000 and $4,000, respectively.
Impaired loans consisted primarily of unsecured consumer loans as of December
31, 1998 and 1997. The average recorded investment in impaired loans for the
years ended December 31, 1998 and 1997 was approximately $10,000 and $36,000,
respectively. No material amount of interest income was recognized on impaired
loans for the years ended December 31, 1998 and 1997. For the years ended
December 31, 1998 and 1997, the difference between gross interest income that
would have been recorded in such period if the nonaccruing loans had been
current in accordance with their original terms and the amount of interest
income on those loans that was included in such period's net income was
negligible.

The Company has no commitments to loan additional funds to the borrowers of
nonaccrual loans.


NOTE 6 - ALLOWANCE FOR LOAN LOSSES

Changes in the allowance for loan losses for each of the three years ended
December 31 were as follows:

<TABLE>
<CAPTION>
                                                                       1998               1997              1996      
                                                                 --------------     ---------------    ---------------
<S>                                                              <C>                <C>                <C>            
Balance at beginning of year..................................   $       929,590    $       655,296    $       324,599

Charge-offs...................................................          (136,222)          (228,087)           (38,225)
Recoveries....................................................            34,947             22,381                922
                                                                 ---------------    ---------------    ---------------
   Net charge-offs............................................          (101,275)          (205,706)           (37,303)

Addition due to acquisition...................................           558,080                -0-                -0-

Provision for loan losses.....................................           300,000            480,000            368,000
                                                                 ---------------    ---------------    ---------------

Balance at end of year........................................   $     1,686,395    $       929,590    $       655,296
                                                                 ===============    ===============    ===============
</TABLE>



                                      F-19
<PAGE>   65

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                  APPALACHIAN BANCSHARES, INC. AND SUBSIDIARIES

                        DECEMBER 31, 1998, 1997 AND 1996




NOTE 7 - PREMISES AND EQUIPMENT

Premises and equipment were as follows:

<TABLE>
<CAPTION>
                                                                                          1998              1997      
                                                                                    ---------------    ---------------
<S>                                                                                 <C>                <C>            
Land ..........................................................................     $       851,546    $       329,900
Buildings and improvements......................................................          2,396,161            964,398
Furniture and equipment.........................................................          1,766,961            671,303
                                                                                    ---------------    ---------------
                                                                                          5,014,668          1,965,601
Less allowance for depreciation.................................................          1,074,636            312,558
                                                                                    ---------------    ---------------

                                                                                    $     3,940,032    $     1,653,043
                                                                                    ===============    ===============

</TABLE>


The provisions for depreciation charged to occupancy and furniture and equipment
expense for the years ended December 31, 1998, 1997 and 1996, were $177,407,
$137,432, and $118,219, respectively.


NOTE 8 - DEPOSITS

The major classifications of deposits as of December 31, 1998 and 1997 were as
follows:

<TABLE>
<CAPTION>
                                                                                          1998              1997      
                                                                                    ---------------    ---------------
<S>                                                                                 <C>                <C>            
Noninterest-bearing demand......................................................    $     9,287,933    $     3,800,911
Interest-bearing demand.........................................................         48,039,917         24,431,854
Savings.........................................................................         29,008,638         20,743,964
Time ...........................................................................         51,576,805         31,635,604
Certificates of deposit of $100,000 or more.....................................         25,948,185         14,735,613
                                                                                    ---------------    ---------------

                                                                                    $   163,861,478    $    95,347,946
                                                                                    ===============    ===============
</TABLE>


The aggregate amounts of time deposits of $100,000 or more, including
certificates of deposit of $100,000 or more at December 31, 1998 and 1997 were
$25,948,185 and $14,735,613, respectively.


                                      F-20

<PAGE>   66

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                  APPALACHIAN BANCSHARES, INC. AND SUBSIDIARIES

                        DECEMBER 31, 1998, 1997 AND 1996




NOTE 8 - DEPOSITS - CONTINUED

The maturities of time certificates of deposit and other time deposits issued by
the Company at December 31, 1998 are as follows:

<TABLE>
<CAPTION>
                                                                                                            Time
                                                                                                        Certificates
                                                                                                         of Deposit   
                                                                                                       ---------------
                  <S>                                                                                  <C>
                  Years ending December 31,
                  -------------------------
                      1999.........................................................................    $    59,935,110
                      2000.........................................................................         10,726,476
                      2001.........................................................................          5,485,078
                      2002.........................................................................            978,565
                      2003.........................................................................            399,761
                      Thereafter...................................................................                -0-
                                                                                                       ---------------
                                                                                                       $    77,524,990
                                                                                                       ===============
</TABLE>


NOTE 9 - LONG-TERM DEBT

At December 31, 1998 and 1997, the Company had notes payable totaling
$11,007,143 and $5,320,000, respectively.

Long-term debt consists of the following at December 31:

<TABLE>
<CAPTION>

                                                                                          1998              1997      
                                                                                    ---------------    ---------------
<S>                                                                                 <C>                <C>            
Note payable to another financial  institution,  interest at prime less 3/4 of
   a percentage  point;  principal is due in five equal annual  installments
   beginning January 1, 1999, unsecured.........................................    $           -0-    $     1,320,000

Note payable on $8 million line of credit at FHLB, with varying maturities; $1
   million due October 2002, $1 million due December 2004, $2 million due June
   and September 2007, $4 million due January, September and October 2008,
   interest rate varies from 5.27% to 6.77%,
   secured by residential mortgages.............................................          7,407,143          4,000,000

Note payable to another financial institution, interest at prime less 3/4 of a
   percentage point; 2 years interest only paid quarterly with principal paid in
   8 annual installments, secured by stock of Gilmer County Bank
   and First National Bank of Union County......................................          3,600,000                -0-
                                                                                    ---------------    ---------------

                                                                                    $    11,007,143    $     5,320,000
                                                                                    ===============    ===============
</TABLE>

                                      F-21
<PAGE>   67

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                  APPALACHIAN BANCSHARES, INC. AND SUBSIDIARIES

                        DECEMBER 31, 1998, 1997 AND 1996




NOTE 9 - LONG-TERM DEBT - CONTINUED

Maturities of long-term debt following December 31, 1998 are as follows:

<TABLE>
<CAPTION>
         Years Ending December 31,
               <S>                                                                                     <C> 
               1999................................................................................    $           -0-
               2000................................................................................                -0-
               2001................................................................................            450,000
               2002................................................................................          1,250,000
               2003................................................................................            450,000
               Thereafter..........................................................................          8,857,143
                                                                                                       ---------------
                                                                                                       $    11,007,143
                                                                                                       ===============
</TABLE>


NOTE 10 - SECURITIES SOLD UNDER AGREEMENT TO REPURCHASE

Securities sold under agreements to repurchase are reflected at the amount of
cash received in connection with the transaction.

Information concerning securities sold under agreements to repurchase is
summarized as follows:

<TABLE>
<CAPTION>
                                                                                          1998              1997      
                                                                                    ---------------    ---------------
<S>                                                                                 <C>                <C>            
Average balance during the year.................................................    $     4,095,716    $     4,471,499
Average interest rate during the year...........................................               4.26%              4.50%
Maximum month-end balance during the year.......................................    $     4,468,355    $     4,693,265
</TABLE>


NOTE 11 - OTHER OPERATING EXPENSES

Other operating expenses consist of the following:

<TABLE>
<CAPTION>
                                                                       1998               1997              1996      
                                                                 ----------------   ---------------    ---------------
<S>                                                              <C>                <C>                <C>            
Professional fees.............................................   $        220,515   $       194,513    $       121,102
Advertising...................................................            203,021           122,358             93,020
Stationery and supplies.......................................            166,137           116,537            105,949
Data processing...............................................            136,256            87,095             46,843
Director and committee fees...................................            125,686           119,322             18,900
Postage.......................................................             89,354            69,806             51,511
Insurance.....................................................             53,554            55,524             26,468
Taxes and licenses............................................             46,788            25,608             22,231
Checking account expense......................................             40,921            32,830             29,751
Correspondent bank charges....................................             35,458            34,648             27,953
Other.........................................................            180,940           119,036             56,048
                                                                 ----------------   ---------------    ---------------

   Total other operating expenses.............................   $      1,298,630   $       977,277    $       599,776
                                                                 ================   ===============    ===============
</TABLE>

                                      F-22
<PAGE>   68

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                  APPALACHIAN BANCSHARES, INC. AND SUBSIDIARIES

                        DECEMBER 31, 1998, 1997 AND 1996




NOTE 12 - INCOME TAXES

Federal and state income taxes receivable (payable) as of December 31, 1998 and
1997 included in other assets and other liabilities, respectively, were as
follows:

<TABLE>
<CAPTION>

                                                                                          1998              1997      
                                                                                    ---------------    ---------------
<S>                                                                                 <C>                <C>             
Current
   Federal......................................................................    $        95,605    $       (25,049)

   State........................................................................                -0-             (3,000)
</TABLE>

The components of the net deferred income tax asset included in other assets are
as follows:

<TABLE>
<CAPTION>
                                                                                          1998              1997      
                                                                                    ---------------    ---------------
<S>                                                                                 <C>                <C>            
Deferred tax asset:
   Federal......................................................................    $       448,671    $       266,289

Deferred tax liability:
   Federal......................................................................            (53,622)           (62,323)
                                                                                    ---------------    ---------------

Net deferred tax asset..........................................................    $       395,049    $       203,966
                                                                                    ===============    ===============
</TABLE>


The tax effects of each type of income and expense item that gave rise to
deferred taxes are:

<TABLE>
<CAPTION>
                                                                                          1998              1997      
                                                                                    ---------------    ---------------
<S>                                                                                 <C>                <C>             
Net unrealized gains on securities available for sale...........................    $       (53,622)   $        (5,034)
Depreciation....................................................................            (54,514)           (57,289)
Allowance for loan losses.......................................................            497,302            253,064
Other...........................................................................              5,883             13,225
                                                                                    ---------------    ---------------

                                                                                    $       395,049    $       203,966
                                                                                    ===============    ===============
</TABLE>

The components of income tax expense for the years 1998, 1997, and 1996 are as
follows:

<TABLE>
<CAPTION>
                                                                       1998               1997              1996      
                                                                 ----------------   ---------------    ---------------
<S>                                                              <C>                <C>                <C>            
   Current
     Federal..................................................   $        597,500   $       456,013    $       312,530
     State....................................................             37,750               -0-                -0-
   Deferred
     Federal..................................................            (63,000)          (73,426)            (8,622)
                                                                 ----------------   ---------------    ---------------

                                                                 $        572,250   $       382,587    $       303,908
                                                                 ================   ===============    ===============

</TABLE>

                                      F-23
<PAGE>   69

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                  APPALACHIAN BANCSHARES, INC. AND SUBSIDIARIES

                        DECEMBER 31, 1998, 1997 AND 1996




NOTE 12 - INCOME TAXES - CONTINUED

Tax effects of securities transactions resulted in an increase (decrease) in
income taxes for 1998, 1997, and 1996 of $5,423, ($27), and $3,024,
respectively.

The principal reasons for the difference in the effective tax rate and the
federal statutory rate are as follows for the years ended December 31, 1998,
1997 and 1996.

<TABLE>
<CAPTION>
                                                                                     1998           1997           1996  
                                                                                    ------         ------         ------
<S>                                                                                 <C>            <C>             <C>  
Statutory federal income tax rate..........................................           34.0%          34.0%         34.0%

Effect on rate of:
   Tax-exempt securities...................................................           (7.2)          (4.1)         (1.0)
   Tax-exempt loans........................................................           (1.1)          (1.0)         (1.1)
   Interest expense disallowance...........................................            1.7            1.0            .4
   State income tax, net of federal tax benefit............................            1.4            -0-           -0-
   Other...................................................................            3.3           (2.6)          4.7
                                                                                    ------          -----         -----

Effective income tax rate..................................................           32.1%          27.3%         37.0%
                                                                                    ======          =====         =====
</TABLE>

NOTE 13 - COMMITMENTS AND CONTINGENCIES

In the normal course of business, the Company offers a variety of financial
products to its customers to aid them in meeting their requirements for
liquidity, credit enhancement, and interest rate protection. Generally accepted
accounting principles recognize these transactions as contingent liabilities
and, accordingly, they are not reflected in the accompanying financial
statements. Commitments to extend credit, credit card arrangements, commercial
letters of credit, and standby letters of credit all include exposure to some
credit loss in the event of nonperformance of the customer. The Company's credit
policies and procedures for credit commitments and financial guarantees are the
same as those for extension of credit that are recorded on the statement of
financial condition. Because these instruments have fixed maturity dates, and
because many of them expire without being drawn upon, they do not generally
present any significant liquidity risk to the Company. Management conducts
regular reviews of these instruments on an individual customer basis, and the
results are considered in assessing the adequacy of the Company's allowance for
loan losses. Management does not anticipate any material losses as a result of
these commitments.

Following is a discussion of these commitments:

Standby Letters of Credit: These agreements are used by the Company's customers
as a means of improving their credit standings in their dealings with others.
Under these agreements, the Company agrees to honor certain financial
commitments in the event that its customers are unable to do so. As of December
31, 1998 and 1997, the Company has issued standby letters of credit of
approximately $643,000 and $385,000.

Loan Commitments: As of December 31, 1998 and 1997, the Company had commitments
outstanding to extend credit totaling approximately $16,290,000 and $11,049,000
respectively. These commitments generally require the customers to maintain
certain credit standards. Management does not anticipate any material losses as
a result of these commitments.



                                      F-24
<PAGE>   70

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                  APPALACHIAN BANCSHARES, INC. AND SUBSIDIARIES

                        DECEMBER 31, 1998, 1997 AND 1996




NOTE 13 - COMMITMENTS AND CONTINGENCIES - CONTINUED

Litigation: The Company is party to litigation and claims arising in the normal
course of business. Management, after consultation with legal counsel, believes
that the liabilities, if any, arising from such litigation and claims are not
material to the financial statements.


NOTE 14 - CONCENTRATIONS OF CREDIT

All of the Company's loans, commitments and standby letters of credit have been
granted to customers in the Company's market area. Substantially all such
customers are depositors of the Company. The concentrations of credit by type of
loan are set forth in Note 4. The commitments to extend credit relate primarily
to unused real estate draw lines. Commercial and standby letters of credit were
granted primarily to commercial borrowers.

The Company maintains its cash accounts at various commercial banks in Georgia.
The total cash balances are insured by the FDIC up to $100,000. Total uninsured
balances held at other commercial banks amounted to $31,000 and $929,000 at
December 31, 1998 and 1997, respectively.


NOTE 15 - STOCK OPTION PLAN

On June 1, 1997 the Company issued a total of 286,000 options, restated for the
2-for-1 stock split, to purchase its common shares to its directors and
executive officers. Each director received 22,000 shares, the Chief Financial
Officer received 44,000 shares and the President received 66,000 shares. Each of
the stock option agreements contained an option price of $8.00 per share, the
market value of the shares at the time of issuance as adjusted for the stock
split. The options vest on an equal incremental basis over a period of five
years beginning June 1, 1998.

The following sets forth certain information regarding stock options for the
year ended December 31, 1998.


<TABLE>
<CAPTION>
Fixed Options                                                       1998                              1997            
--------------                                       ---------------------------------  ------------------------------
                                                                          WEIGHTED                          Weighted
                                                                           AVERAGE                           Average
                                                                          EXERCISE                          Exercise
                                                         SHARES            PRICE            Shares           Price    
                                                     -------------     ---------------  ------------      ------------
<S>                                                  <C>               <C>              <C>               <C> 
Outstanding at beginning of year.................         286,000      $          8.00           -0-      $        -0-
Granted..........................................              -0-                0.00       286,000              8.00
Exercised........................................          30,800                 8.00           -0-               -0-
Forfeited........................................              -0-                0.00           -0-              8.00
                                                     -------------     ---------------  ------------      ------------

Outstanding at end of year.......................         255,200      $          8.00       286,000      $       8.00
                                                     ============      ===============  ============      ============

Exercisable at end of year.......................          26,400      $          8.00           -0-      $        -0-
                                                     ============      ===============  ============      ============
</TABLE>


                                      F-25
<PAGE>   71

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                  APPALACHIAN BANCSHARES, INC. AND SUBSIDIARIES

                        DECEMBER 31, 1998, 1997 AND 1996




NOTE 15 - STOCK OPTION PLAN - CONTINUED

<TABLE>
<CAPTION>
                                                                                    Expiration          Options
                                                                     Number            Date           Exercisable  
                                                                    --------        ----------        -----------  
<S>                                                                 <C>             <C>               <C>   
Options with Exercise Price of $8.00..........................       255,200         06-01-07            26,400
</TABLE>

In October 1995, the FASB issued Financial Accounting Standards No. 123,
Accounting and Disclosure of Stock-Based Compensation ("SFAS 123") SFAS 123 is
effective for years beginning after December 15, 1995, and allows for the option
of continuing to follow Accounting Principles Board Opinion No. 25, Accounting
for Stocks Issued to Employees, and the related Interpretations or selecting the
minimum value method of expense recognition as described in SFAS 123. The
Company has elected to apply APB Opinion No. 25 in accounting for its incentive
stock options, accordingly, no compensation cost has been recognized by the
Company. The Company's net income and earnings per share would have been reduced
to the pro forma amounts indicated below had compensation cost for the Company's
stock option plan been determined based on the fair value method at the grant
date for options under the plan.

<TABLE>
<CAPTION>
                                                                                          1998              1997      
                                                                                    ---------------    ---------------
<S>                                                                                 <C>                <C>            
Net Income
   As reported..................................................................    $     1,208,231    $     1,017,766
   Pro forma....................................................................          1,125,073            870,834

Basic Earnings Per Share
   As reported..................................................................    $          1.04    $          0.88
   Pro forma....................................................................               0.96               0.75

Diluted Earnings Per Share
   As reported..................................................................    $          0.99    $          0.88
   Pro forma....................................................................               0.92               0.75
</TABLE>

These options are assumed to be exercised in the calculation of diluted average
common shares outstanding, causing the equivalent number of shares outstanding
on a diluted basis to be 54,551 greater than that used to calculate basic
earnings per share for 1998 and 7,216 greater than that used to calculate basic
earnings per share for 1997. The dilutive effects on earnings per share for the
years ended December 31, 1998 and 1997 were $.05 and $.01, respectively.

The Company's options outstanding have a weighted average contractual life of
nine years. The weighted average fair value of options granted was $1.89 in
1997. The fair value of each grant is estimated using a fair value method with
the following assumptions used for grants in 1997: expected option life of 10
years; no expected volatility; expected dividend yield of 2.05%; and a risk free
interest rate of 7.00%.

The effects of applying FAS 123 for providing proforma disclosures are not
likely to be representative of the effects on reported earnings for future
years, nor are the dividend estimates representative of commitments on the part
of the Company's Board.


                                      F-26
<PAGE>   72

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                  APPALACHIAN BANCSHARES, INC. AND SUBSIDIARIES

                        DECEMBER 31, 1998, 1997 AND 1996




NOTE 16 - SHAREHOLDERS' EQUITY

The board of directors of any state-chartered bank in Georgia may declare and
pay cash dividends on its outstanding capital stock without any request for
approval of the Company's regulatory agency if the following conditions are met:

1.  Total classified assets at the most recent examination of the Company do
    not exceed 80% of equity capital.

2.  The aggregate amount of dividends declared in the calendar year does not
    exceed 50% of the prior year's net income.

3.  The ratio of equity capital to adjusted assets shall not be less than 6%.

As of December 31, 1998, the Banks could declare dividends of approximately
$707,000 without regulatory consent, subject to the Banks' compliance with
regulatory capital restrictions. It is anticipated that any such dividends will
be used for the payment of long term debt service.

In May 1998, the Company issued a 2-for-1 stock split. All per share amounts
included in these financial statements have been retroactively adjusted to give
effect to this split.

In 1998, the Company sold 19,314 shares of stock to its ESOP plan for $310,628.
Of this amount $96,570 was allocated to common stock and $214,058 to capital
surplus. The Company also purchased 14,000 shares of common stock for $154,000,
which is reflected as treasury stock, at cost, in shareholder's equity. During
1998, the Company sold 132,500 shares of stock in a private placement sale for
$2,650,000, of which $662,500 was allocated to common stock and $1,987,500 to
capital surplus. In addition, 30,800 options were exercised for an amount
equaling $394,240, including tax benefit of $147,840, allocated among common
stock, $154,000 and capital surplus, $240,240.

In 1997, the Company sold 24,287 shares of stock to its ESOP plan for $388,607.
Of this amount, $242,870 was allocated to common stock and $145,737 to capital
surplus. The Company also purchased 30,000 shares of common stock for $274,000,
which is reflected as treasury stock, at cost, in shareholder's equity.

The Company is also required to maintain minimum amounts of capital to total
"risk weighted" assets, as defined by the banking regulators. The Company's
ratios as of December 31, 1998 and December 31, 1997 are disclosed in note 16
following.


NOTE 17 - REGULATORY MATTERS

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


                                      F-27
<PAGE>   73

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                  APPALACHIAN BANCSHARES, INC. AND SUBSIDIARIES

                        DECEMBER 31, 1998, 1997 AND 1996




NOTE 17 - REGULATORY MATTERS - CONTINUED

Quantitative measures established by regulation to ensure capital adequacy
require the Company and its subsidiary banks to maintain minimum amounts and
ratios (set forth in the table below) of total and Tier 1 Capital (as defined in
the regulations) to risk weighted assets (as defined), and of Tier I Capital (as
defined) to average assets (as defined). Management believes, as of December 31,
1998, that the Banks meet all capital adequacy requirements to which they are
subject.

As of December 31, 1998, the most recent notification from the appropriate
regulatory agencies categorized the subsidiary banks as well capitalized under
the regulatory framework for prompt corrective action. To remain well
capitalized the Company and its subsidiary banks will have to maintain minimum
Total Capital, Tier I Capital, and Tier I Leverage ratios as set forth in the
table below. There are no conditions or events since that notification or events
since the most recent notification that management believes have changed the
Banks' prompt corrective action category.

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

<TABLE>
<CAPTION>
                                                                                             To Be Well Capitalized
                                                                                                   Under Prompt
                                                                       For Capital             Corrective Action
                                               Actual               Adequacy Purposes               Provisions      
                                          -----------------         -----------------        ----------------------
                                            Amount    Ratio         Amount       Ratio           Amount      Ratio  
                                          ---------   -----         ------       -----       -----------    -------
                                                                     (in Thousands)
<S>                                       <C>         <C>          <C>           <C>         <C>            <C>  
AS OF DECEMBER 31, 1998:

TOTAL CAPITAL
   CONSOLIDATED                           $  10,721    7.88%       $   10,890      8.0%      $    13,612    10.0%
   GILMER COUNTY BANK                        10,248    9.92             8,266      8.0            10,332    10.0
   FIRST NATIONAL BANK OF UNION CO.           4,147   12.70             2,612      8.0             3,265    10.0
TIER 1 CAPITAL
   CONSOLIDATED                               9,035    6.64             5,445      4.0             8,167     6.0
   GILMER COUNTY BANK                         9,120    8.83             4,133      4.0             6,199     6.0
   FIRST NATIONAL BANK OF UNION CO.           3,737   11.44             1,306      4.0             1,959     6.0
TIER 1 LEVERAGE
   CONSOLIDATED                               9,035    4.99             7,242      4.0             9,053     5.0
   GILMER COUNTY BANK                         9,120    6.70             5,445      4.0             6,806     5.0
   FIRST NATIONAL BANK OF UNION CO.           3,737    8.32             1,798      4.0             2,247     5.0

As of December 31, 1997:

Total Capital
   Consolidated                           $   7,846    9.33%       $    6,726      8.0%      $     8,407    10.0%
   Gilmer County Bank                         9,103   10.83             6,726      8.0             8,407    10.0
Tier 1 Capital
   Consolidated                               6,916    8.23             3,363      4.0             5,044     6.0
   Gilmer County Bank                         8,173    9.72             3,363      4.0             5,044     6.0
Tier 1 Leverage
   Consolidated                               6,916    6.40             4,321      4.0             5,402     5.0
   Gilmer County Bank                         8,173    7.56             4,322      4.0             5,403     5.0
</TABLE>


                                      F-28
<PAGE>   74

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                  APPALACHIAN BANCSHARES, INC. AND SUBSIDIARIES

                        DECEMBER 31, 1998, 1997 AND 1996




NOTE 18 - EMPLOYEE BENEFIT PLAN

The Company adopted a defined contribution plan covering substantially all
employees; the plan is qualified under Section 401(k) of the Internal Revenue
Code. Under the provisions of the plan, eligible participating employees may
elect to contribute up to the maximum amount of tax deferred contribution
allowed by the Internal Revenue Code. The Company's contribution to the plan is
determined by the board of directors. In 1996, the plan was amended to allow
employer and employee contributions to be made in the form of cash or Company
stock. The Company made a discretionary cash contributions to the plan of
approximately $145,000 in 1998, $102,000 in 1997, and $28,000 in 1996.


NOTE 19 - LEASES

The Company has a number of operating lease agreements, involving land,
buildings, and equipment. These leases are noncancellable and expire on various
dates through the year 2028. The leases provide for renewal options and
generally require the Company to pay maintenance, insurance, and property taxes.
For the year ended December 31, 1998, rental expense for operating leases was
approximately $3,000. Rental expense for the years ended December 31, 1997 and
1996 was negligible.

<TABLE>
<CAPTION>
         Years Ending December 31,
         <S>                                                                                           <C>            
               1999................................................................................    $        32,988
               2000................................................................................             32,890
               2001................................................................................             31,800
               2002................................................................................             32,400
               2003................................................................................             33,024
               Thereafter..........................................................................          1,023,716
                                                                                                       ---------------

               Total minimum lease payments........................................................    $     1,186,818
                                                                                                       ===============
</TABLE>


NOTE 20 - RELATED PARTY TRANSACTIONS

Loans: Certain directors, executive officers and principal shareholders,
including their immediate families and associates were loan customers of the
Company during 1998 and 1997. Such loans are made in the ordinary course of
business at normal credit terms, including interest rates and collateral and do
not represent more than a normal risk of collection. A summary of activity and
amounts outstanding are as follows:

<TABLE>
<S>                                                                                                    <C>            
Balance at December 31, 1997.......................................................................    $     4,133,302
New loans..........................................................................................          2,757,808
Repayments.........................................................................................         (2,122,202)
Adjustments/changes in structure...................................................................            694,122
                                                                                                       ---------------

Balance at December 31, 1998.......................................................................    $     5,463,030
                                                                                                       ===============
</TABLE>

Deposits: Deposits held from related parties were $1,208,198 and $918,848 at
December 31, 1998 and 1997, respectively.


                                      F-29
<PAGE>   75

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                  APPALACHIAN BANCSHARES, INC. AND SUBSIDIARIES

                        DECEMBER 31, 1998, 1997 AND 1996


NOTE 20 - RELATED PARTY TRANSACTIONS - CONTINUED

Other: The Company utilized the services of an accounting firm, of which a
director is a partner, for internal review and various other accounting and tax
services. Amounts paid were at a rate comparable to that which could have been
obtained from unrelated parties.


NOTE 21 - FAIR VALUE OF FINANCIAL INSTRUMENTS

The following methods and assumptions were used to estimate the fair value of
each class of financial instruments for which it is practicable to estimate that
value:

Cash and Short-Term Investments: For those short-term instruments, the carrying
amount is a reasonable estimate of fair value.

Securities: For securities and marketable equity securities held for investment
purposes, fair values are based on quoted market prices or dealer quotes. For
other securities held as investments, fair value equals quoted market price, if
available. If a quoted market price is not available, fair value is estimated
using quoted market prices for similar securities.

Loans: For certain homogeneous categories of loans, such as some residential
mortgages, credit card receivables, and other consumer loans, fair value is
estimated using the quoted market prices for securities backed by similar loans,
adjusted for differences in loan characteristics. The fair value of other types
of loans is estimated by discounting the future cash flows using the current
rates at which similar loans would be made to borrowers with similar credit
ratings and for the same remaining maturities.

Accrued Interest Receivable: The carrying amount of accrued interest receivable
approximates its fair value.

Deposits: The fair value of demand deposits, savings accounts, and certain money
market deposits is the amount payable on demand at the reporting date. The fair
value of fixed-maturity certificates of deposit is estimated using the rates
currently offered for deposit of similar remaining maturities.

Accrued Interest Payable: The carrying amount of accrued interest payable
approximates its fair value.

Short-term Borrowings: The fair value of short-term borrowings, including
securities sold under agreements to repurchase, is estimated to be approximately
the same as the carrying amount.

Long-Term Debt: Rates currently available to the Company for debt with similar
terms and remaining maturities are used to estimate fair value of existing debt.

Commitments to Extend Credit, Standby Letters of Credit, and Financial
Guarantees Written: The fair value of commitments and letters of credit is
estimated to be approximately the same as the notional amount of the related
commitment.

                                      F-30
<PAGE>   76

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                  APPALACHIAN BANCSHARES, INC. AND SUBSIDIARIES

                        DECEMBER 31, 1998, 1997 AND 1996




NOTE 21 - FAIR VALUE OF FINANCIAL INSTRUMENTS - CONTINUED

The estimated fair values of the Company's financial instruments as of December
31 are as follows:


<TABLE>
<CAPTION>
                                                                 1998                               1997               
                                                     ------------------------------     ------------------------------
                                                        CARRYING           FAIR            Carrying           Fair
                                                         AMOUNT            VALUE            Amount            Value   
                                                     ------------      ------------     ------------      ------------
                                                               (IN THOUSANDS)                   (in thousands)
<S>                                                  <C>               <C>              <C>               <C>         
FINANCIAL ASSETS
Cash and short-term investments..................    $     24,281      $     24,281     $      5,211      $      5,211
Securities.......................................          28,159            28,398           19,726            19,854
Loans............................................         129,831           129,685           84,584            84,683
Accrued interest receivable......................           1,320             1,320              972               972
                                                     ------------      ------------     ------------      ------------
   TOTAL FINANCIAL ASSETS........................    $    183,591      $    183,684     $    110,493      $    110,720
                                                     ============      ============     ============      ============

FINANCIAL LIABILITIES
Deposits.........................................    $    163,861      $    164,921     $     95,348      $     95,479
Securities sold under agreements to repurchase...           2,478             2,478            4,228             4,228
Accrued interest payable.........................             666               666              188               188
Long-term debt...................................          11,007            11,192            5,320             5,376
                                                     ------------      ------------     ------------      ------------
   TOTAL FINANCIAL LIABILITIES...................    $    178,012      $    179,257     $    105,084      $    105,271
                                                     ============      ============     ============      ============

UNRECOGNIZED FINANCIAL INSTRUMENTS
Commitments to extend credit.....................    $     16,290      $     16,290     $     11,049      $     11,049
Standby letters of credit........................             643               643              385               385
                                                     ------------      ------------     ------------      ------------
   TOTAL UNRECOGNIZED FINANCIAL
     INSTRUMENTS.................................    $     16,933      $     16,933     $     11,434      $     11,434
                                                     ============      ============     ============      ============
</TABLE>


NOTE 22 - YEAR 2000 ISSUES

The Year 2000 issue is the result of shortcomings in many electronic data
processing systems and other electronic equipment that may adversely affect the
Company's operations as early as fiscal year 1999.

The Company has completed an inventory of computer systems and other electronic
equipment that may be affected by the Year 2000 issue and that are necessary to
conducting the Company's operations. Based on this inventory, the Company has
upgraded or replaced various software and hardware items. Testing and validation
of the system for the Year 2000 compliance is currently being performed.

Because of the unprecedented nature of the Year 2000 issue, its effects and the
success of related remediation efforts will not be fully determinable until the
Year 2000 and thereafter.


                                      F-31
<PAGE>   77

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                  APPALACHIAN BANCSHARES, INC. AND SUBSIDIARIES

                        DECEMBER 31, 1998, 1997 AND 1996



NOTE 23 - CONDENSED PARENT INFORMATION

STATEMENTS OF FINANCIAL CONDITION

<TABLE>
<CAPTION>
                                                                                                 DECEMBER 31,        
                                                                                    ----------------------------------     
                                                                                          1998              1997      
                                                                                    ---------------    ---------------
<S>                                                                                 <C>                <C>            
ASSETS
   Cash and due from banks......................................................    $        28,222    $        63,487
   Investment in Subsidiaries (equity method) eliminated upon consolidation.....         15,301,472          8,215,672
   Intangibles, net.............................................................                -0-             20,894
   Other assets.................................................................                -0-                -0-
                                                                                    ---------------    ---------------
     TOTAL ASSETS...............................................................    $    15,329,694    $     8,300,053
                                                                                    ===============    ===============

LIABILITIES AND SHAREHOLDERS' EQUITY
   Note payable.................................................................    $     3,600,000    $     1,320,000
   Other liabilities............................................................            250,000                -0-
                                                                                    ---------------    ---------------
     Total Liabilities..........................................................          3,850,000          1,320,000

     Total Shareholders' Equity.................................................         11,479,694          6,980,053
                                                                                    ---------------    ---------------

TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY......................................    $    15,329,694    $     8,300,053
                                                                                    ===============    ===============
</TABLE>


STATEMENTS OF INCOME

<TABLE>
<CAPTION>
                                                                           YEARS ENDED DECEMBER 31,             
                                                                 ----------------------------------------------      
                                                                      1998            1997              1996     
                                                                 -------------   ------------     ------------
<S>                                                              <C>             <C>              <C>
INCOME
   Dividends from subsidiaries - eliminated upon consolidation   $     500,000   $        -0-           30,000

EXPENSES
   Interest...................................................          93,406         78,517            4,667
   Other expenses.............................................         135,701         15,525            2,430
                                                                 -------------   ------------     ------------
                                                                       229,107         94,042            7,097
                                                                 -------------   ------------     ------------

Income before income taxes and equity in undistributed
   earnings of subsidiaries...................................         270,893        (94,042)          22,903
Income tax benefits...........................................         (42,101)       (30,913)          (2,413)
                                                                 -------------   ------------     ------------

Income before equity in undistributed earnings of subsidiaries         312,994        (63,129)          25,316

Equity in undistributed earnings of subsidiaries..............         895,237      1,080,895          491,420
                                                                 -------------   ------------     ------------

     Net Income...............................................   $   1,208,231   $  1,017,766     $    516,736
                                                                 =============   ============     ============
</TABLE>

                                      F-32

<PAGE>   78

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                  APPALACHIAN BANCSHARES, INC. AND SUBSIDIARIES

                        DECEMBER 31, 1998, 1997 AND 1996




NOTE 23 - CONDENSED PARENT INFORMATION - CONTINUED

STATEMENTS OF CASH FLOW

<TABLE>
<CAPTION>

                                                                                YEARS ENDED DECEMBER 31,             
                                                                 ----------------------------------------------------
                                                                       1998               1997              1996     
                                                                 ----------------   ---------------    --------------
<S>                                                              <C>                <C>                <C>           
CASH FLOWS FROM OPERATING ACTIVITIES
   Net Income.................................................   $      1,208,231   $    1,017,766     $      516,736
   Adjustments to reconcile net income to net cash
     provided by operating activities
     Equity in undistributed income of subsidiaries...........           (895,237)      (1,080,895)          (491,420)
     Provision for amortization...............................                -0-            5,832              2,430
     Other....................................................            270,873           (4,667)           (26,902)
                                                                 ----------------   --------------     --------------
       NET CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES....            583,867          (61,964)               844
                                                                 ----------------   --------------     --------------

CASH FLOWS FROM INVESTING ACTIVITIES
   Acquisition of bank........................................         (6,100,000)             -0-                -0-
   Capital injection in subsidiaries..........................                -0-         (610,000)          (700,000)
                                                                 ----------------   --------------     --------------
       NET CASH USED IN INVESTING ACTIVITIES..................         (6,100,000)        (610,000)          (700,000)
                                                                 ----------------   ---------------    --------------

CASH FLOWS FROM FINANCING ACTIVITIES
   Proceeds from issuance of long-term debt...................          3,600,000          620,000            700,000
   Repayment of long-term debt................................         (1,320,000)             -0-                -0-
   Proceeds from issuance of common stock.....................          3,354,868          388,607                -0-
   Purchases of treasury stock................................           (154,000)        (274,000)               -0-
                                                                 ----------------   --------------     --------------
       NET CASH PROVIDED BY FINANCING ACTIVITIES..............          5,480,868          734,607            700,000
                                                                 ----------------   --------------     --------------

NET INCREASE IN CASH AND CASH EQUIVALENTS.....................            (35,265)          62,643                844
                                                                 ----------------   --------------     --------------

Cash and cash equivalents at beginning of year................             63,487              844                -0-
                                                                 ----------------   --------------     --------------

CASH AND CASH EQUIVALENTS AT END OF YEAR......................   $         28,222   $       63,487     $          844
                                                                 ================   ==============     ==============

Cash paid during the year for:
   Interest...................................................   $         93,406   $       83,184     $          -0-
</TABLE>

                                      F-33
<PAGE>   79

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                  APPALACHIAN BANCSHARES, INC. AND SUBSIDIARIES

                        DECEMBER 31, 1998, 1997 AND 1996


NOTE 24 - QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)

Selected quarterly results of operations for the four quarters ended December 31
are as follows:

<TABLE>
<CAPTION>
                                                    First          Second             Third           Fourth
                                                   Quarter         Quarter           Quarter          Quarter    
                                                   -------        ----------         -------         ---------    
                                                               (In Thousands Except Per Share Data)
<S>                                            <C>                <C>                <C>             <C>      
1998:
TOTAL INTEREST INCOME.......................   $    2,514         $   2,677          $ 2,761         $   3,318
TOTAL INTEREST EXPENSE......................        1,464             1,581            1,620             1,832
PROVISION FOR LOAN LOSSES...................          110                70               60                60
NET INTEREST INCOME AFTER
   PROVISION FOR LOAN LOSSES................          940             1,026            1,081             1,426
SECURITIES GAINS (LOSSES)...................          -0-                14                1               -0-
TOTAL NONINTEREST INCOME....................          109               125              128               152
TOTAL NONINTEREST EXPENSE...................          660               742              783             1,036
INCOME TAX EXPENSE..........................          150               130              120               172
NET INCOME..................................          239               293              307               370

PER COMMON SHARE:
   BASIC EARNINGS...........................         0.21              0.25             0.27              0.31
   DILUTED EARNINGS.........................         0.20              0.24             0.25              0.30

1997:
Total interest income.......................   $    2,170         $   2,175          $ 2,298         $   2,499
Total interest expense......................        1,211             1,277            1,347             1,427
Provision for loan losses...................          140                75               85               180
Net interest income after
   provision for loan losses................          819               823              866               892
Securities gains (losses)...................            5                (5)               1               -0-
Total noninterest income....................           81               105               98                94
Total noninterest expense...................          549               600              606               624
Income tax expense..........................          115               100              120                48
Net income..................................          241               223              239               314

Per Common Share:
   Basic earnings...........................         0.21              0.20             0.21              0.26
   Diluted earnings.........................         0.21              0.20             0.20              0.26
</TABLE>



                                      F-34
<PAGE>   80
                                  EXHIBIT INDEX


<TABLE>
<CAPTION>
EXHIBIT NUMBER                                       DESCRIPTION OF EXHIBIT
--------------                                       ----------------------
<S>                          <C>
    2.1                      Purchase Sale and Assumption Agreement, dated July 10, 1998, by and                
                             between Century South Banks, Inc. and the Company (included as Exhibit             
                             2.1 to the Current Report on Form 8-K of the Company dated November 30,            
                             1998 (File No. 000-21383) previously filed with the Commission and                 
                             incorporated herein by reference).                                                 
                                                                                                                
    3.1                      Articles of Incorporation of the Company (included as Exhibit 3.1 to               
                             the Company's Registration Statement on Form 8-A, dated September 16,              
                             1996 (File No. 000-21383), previously filed with the Commission and
                                                                                                             
    3.2                      Bylaws of the Company (included as Exhibit 3.2 to the Company's                    
                             Registration Statement on Form 8-A, dated September 16, 1996 (File
                             No. 000-21383), previously filed with the Commission and
                             incorporated herein by reference).

    4.1                      Registration Rights Agreement, dated November 30, 1998, by and among               
                             the Company and Community Financial Services, Inc.                                 
                                                                                                                
    4.2                      Registration Rights Agreement, dated November 30, 1998, by and among               
                             the Company and Ellijay Telephone Company, Inc.                                    
                                                                                                                
    4.3                      Registration Rights Agreement, dated November 30, 1998, by and among               
                             the Company and JBC Bancshares, Inc.                                               
                                                                                                                
    10.1                     1997 Directors' Non-Qualified Stock Option Plan (included as Exhibit               
                             10.1 to the Company's Annual Report on Form 10-KSB for the fiscal year             
                             ended December 31, 1996 (File No. 000-21383) and incorporated herein by            
                             reference).*                                                                       
                                                                                                                
    10.2                     1997 Employee Incentive Stock Incentive Plan (included as Exhibit 10.2             
                             to the Company's Annual Report on Form 10-KSB for the fiscal year ended            
                             December 31, 1996 (File No. 000-21383) and incorporated herein by                  
                             reference).*

    10.3                     Adoption Agreement for the Appalachian Bancshares, Inc. Section 401(k)             
                             Profit Sharing Plan (filed as Exhibit 4.3(a) to the Company's                      
                             Registration Statement on Form S-8 (No. 333-27127) and incorporated                
                             herein by reference).                                                              
                                                                                                                
    10.4                     Georgia Bankers Association Master 401(k) Profit Sharing Plan (filed as            
                             Exhibit 4.3(b) to the Company's Registration Statement on Form S-8 (No.            
                             333-27127) and incorporated herein by reference).                                  
                                                                                                                
    10.5                     First Amendment to the Georgia Bankers Association Master Section                  
                             401(k) Profit Sharing Plan (filed as Exhibit 4.3(c) to the Company's               
                             Registration Statement on Form S-8 (No. 333-27127) and incorporated                
                             herein by reference).                                                              
</TABLE>
<PAGE>   81
<TABLE>
    <S>                      <C>                                                                                
    10.6                     Form of Deferred Fee Agreement between Gilmer County Bank and certain              
                             directors and executive officers, with addendum (filed as Exhibit 10.6             
                             to the Company's Quarterly Report on Form 10-QSB for the period ended              
                             June 30, 1997 (File No. 000-21383) and incorporated herein by                      
                             reference).
                                                                        
    10.7                     Loan and Stock Pledge Agreement, dated as of November 30, 1998, between            
                             the Company and The Bankers Bank.                                                  
                                                                                                                
    10.8                     Promissory Note, dated November 30, 1998, issued by the Company to The             
                             Bankers Bank.                                                                      
                                                                                                                
    11                       Statement re: Computation of Per Share Earnings                                    
                                                                                                                
    21                       Subsidiaries of the Registrant                                                     
                                                                                                                
    23                       Consent of Independent Auditors                                                    
                                                                                                                
    27                       Financial Data Schedule (for SEC use only)
                                                                                                                
    99                       Information required by Form 11-K with respect to the Appalachian                  
                             Bancshares, Inc. Section 401(k) Profit Sharing Plan will be filed as an            
                             amendment to this Form 10-KSB within 180 days after the end of the                 
                             fiscal year of the plan as permitted by Rule 15d-21 under the                      
                             Securities Exchange Act of 1934.                                                   
</TABLE>                   

* The referenced exhibit is a compensatory contract, plan or arrangement.