<PAGE>
 
                       SECURITIES AND EXCHANGE COMMISSION
                            Washington, D.C.  20549
                              --------------------
                                  FORM 10-KSB

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

For the fiscal year ended June 30, 1998


[_]         TRANSITIONAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
            SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED]

For the transition period from ______________ to _______________

                          Commission File No. 0-20956
                                              -------

                           HFB FINANCIAL CORPORATION
             ------------------------------------------------------             
             (Exact name of registrant as specified in its charter)

           Tennessee                                    61-1228266
---------------------------------                   ------------------
  (State or other jurisdiction                       (I.R.S. employer
of incorporation or organization)                   identification no.)

1602 Cumberland Avenue, Middlesboro, Kentucky              40965
---------------------------------------------            ----------
  (Address of principal executive offices)               (Zip Code)
                  

      Registrant's telephone number, including area code:  (606) 248-1095

  Securities registered pursuant to Section 12(b) of the Act:  Not Applicable

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

                    Common Stock (par value $1.00 per share)
                    ----------------------------------------
                                 Title of Class

Indicate by check mark whether the registrant (1) has filed all reports required
by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 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 
    -----     -----        

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-B is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-KSB or any amendment to
this Form 10-KSB.  [X]

Registrant's revenues for the fiscal year ended June 30, 1998:  $13,640,000

The registrant's voting stock is listed on the OTC Bulletin Board published by
the National Association of Securities Dealers ("OTC Bulletin Board").  The
aggregate market value of the voting stock held by nonaffiliates of the
registrant, based on the $19.125 per share closing sales price of the
registrant's common stock as quoted on the OTC Bulletin Board on September 30,
1998, was $16,815,388.  For purposes of this calculation, it is assumed that
directors and officers of the registrant are affiliates.  As of September 30,
1998, the registrant had 1,089,648 shares of common stock outstanding, of which
210,412 were held by affiliates.

Transitional Small Business Disclosure Format   Yes        No  X
                                                    ---       ---     


                      DOCUMENTS INCORPORATED BY REFERENCE

     1.   Portions of Annual Report to Stockholders for the Fiscal Year Ended
          June 30, 1998.  (Parts I and II)

     2.   Portions of Proxy Statement for the 1998 Annual Meeting of
          Stockholders.  (Part III)
<PAGE>
 
                                     PART I


ITEM 1.  BUSINESS
-----------------

GENERAL

     THE COMPANY.  HFB Financial Corporation (the "Company"), a Tennessee
corporation, was organized by Home Federal Bank, Federal Savings Bank ("Home
Federal" or the "Bank") to be a savings institution holding company.  The
Company was organized at the direction of the Bank in September 1992 to acquire
all of the capital stock to be issued by the Bank upon the conversion of the
Bank from mutual to stock form and the simultaneous offering and sale of 722,704
shares of common stock, par value $1.00 per share (the "Common Stock"), of the
Company, which was completed on December 28, 1992 (the "Conversion").  The
Company has no significant assets other than capital stock of the Bank, a
portfolio of trading account equity securities and a loan to the Bank's employee
stock ownership plan.  Since the Conversion, the Company has repurchased 202,046
shares of its outstanding Common Stock at a cost of $2.0 million, and paid cash
dividends of $2.0 million.  The Company is a unitary savings and loan holding
company subject to regulation by the Office of Thrift Supervision ("OTS").  The
Company's principal business is the business of the Bank and its subsidiary.
Therefore, substantially all of the discussion in this Form 10-KSB relates to
the Bank and its operations.  At June 30, 1998, the Corporation (on a
consolidated basis with the Bank) had total assets of $176.4 million, deposits
of $144.9 million, net loans receivable of $116.2 million and stockholders'
equity of $18.0 million.

     The executive offices of the Company and the Bank are located at 
1602 Cumberland Avenue, Middlesboro, Kentucky 40965, and the telephone number 
is (606) 248-1095.

     THE BANK.  Home Federal was incorporated in 1920 as a Kentucky-chartered
building and loan association known as Peoples Building and Loan.  The Bank
converted to a federal savings and loan association and obtained federal
insurance of accounts in 1961, and became a federally chartered mutual savings
bank, Home Federal Savings Bank, in 1985.  The Bank changed to its current name,
Home Federal Bank, Federal Savings Bank, in 1990.  The Bank completed its
conversion from mutual to stock form on December 28, 1992.  The Bank operates
through two full service offices in the Southeastern Kentucky communities of
Middlesboro and Harlan and one full service office in the East Tennessee
community of New Tazewell.

     The Bank is engaged principally in the business of accepting deposits from
the general public and originating permanent loans which are secured by one- to
four-family residential properties located in its market area.  The Bank also
originates consumer loans and commercial real estate loans, and maintains a
substantial investment portfolio of mortgage-backed and other investment
securities.

     Home Federal's current business strategy embodies several objectives: 
(i) continued emphasis on originating interest rate sensitive or shorter term
loans for portfolio, primarily in the form of longer term adjustable-rate
mortgage loans and shorter term consumer loans, (ii) continued maintenance of a
substantial investment portfolio of short-term, low-risk investments, primarily
U.S. government and agency securities and investment grade mortgage-backed
securities, and (iii) expanding the Bank's loan originations in the counties
adjacent to the Bank's market area.  Also, from time to time the Bank has
purchased whole loans and participation interests in residential and commercial
real estate and multi-family real estate loans located primarily in Kentucky and
East Tennessee, areas contiguous to the Bank's immediate market area.

     The Bank has taken certain actions in order to address issues relating to
the Year 2000, and the proper functioning of computer and data processing
equipment.  For more information, see "Item 6. -- Management's Discussion and
Analysis of Financial Condition and Results of Operations."

                                       2
<PAGE>
 
MARKET AREA

     Home Federal's offices are located in Bell and Harlan Counties in
southeastern Kentucky and Claiborne County in northeastern Tennessee.  The Bell
County office, which is located in Middlesboro, Kentucky, primarily serves a
deposit market in within a twenty mile radius of Middlesboro and a lending
market comprised of Hamblin and Campbell Counties in northeastern Tennessee,
Bell, Harlan, Knox, Whitley and Laurel Counties in southeastern Kentucky and Lee
County in southwestern Virginia.  The Harlan County office serves a deposit
market primarily consisting of Harlan County and the city of Harlan and the
Claiborne County office, which is located in New Tazewell, Tennessee, serves a
deposit and loan market in Claiborne, Grainger, Union and Knox Counties in
northeastern Tennessee.  Management has significantly increased its loan and
deposit markets in northeastern Tennessee through its New Tazewell office, which
opened in October 1995 and deposits in this branch totaled $26.4 million at June
30, 1998, while loans originated on Northeastern Tennessee properties during
fiscal 1998 approximated $12.4 million.

     The Bank serves the northeastern Tennessee and southeastern Kentucky loan
markets from its Middlesboro and New Tazewell offices.  Employment in these
counties is primarily reliant on local manufacturing industries with significant
employment also coming from services, retail sales, the transportation, utility
and construction industries, agriculture and mining.

     The Bell and Harlan county markets are the Bank's primary source of
deposits with a smaller percentage of loans coming from this area.  The economy
in Bell and Harlan Counties has suffered from the loss of jobs in the coal
industry since the 1980s.  Both counties are gradually recovering by means of
diversification into other industries.  In the last few years, Bell County has
experienced substantial growth in the retail sector with the development and
expansion of several shopping centers.  Other sources of employment in Bell and
Harlan Counties include manufacturing, utilities, transportation and services.

PROPOSED REGULATORY AND LEGISLATIVE CHANGES

     On May 13, 1998, the U.S. House of Representatives by one vote passed 
H.R. 10 (the "Act"), the "Financial Services Competition Act of 1998," which
calls for a sweeping modernization of the banking system that would permit
affiliations between commercial banks, securities firms, insurance companies
and, subject to certain limitations, other commercial enterprises.  The stated
purposes of the Act are to enhance consumer choice in the financial services
marketplace, level the playing field among providers of financial services and
increase competition.

     The Act removes the restrictions contained in the Glass-Steagall Act of
1933 and the Bank Holding Company Act of 1956, thereby allowing qualified
financial holding companies to control banks, securities firms, insurance
companies, and other financial firms.  Conversely, securities firms, insurance
companies and financial firms would be allowed to own or affiliate with a
commercial bank.  Under the new framework, the Federal Reserve would serve as an
umbrella regulator to oversee the new financial holding company structure.
Securities affiliates would be required to comply with all applicable federal
securities laws, including registration and other requirements applicable to
broker-dealers.  The Act also provides that insurance affiliates be subject to
applicable state insurance regulations and supervision.  The Act preserves the
thrift charter and all existing thrift powers, but restricts the activities of
new unitary thrift holding companies.

     The Senate is now considering the legislation, but may further modify the
Act.  At this time, it is unknown whether the Act will be enacted, or if
enacted, what form the final version of such legislation might take.

SPECIAL NOTE REGARDING FORWARD LOOKING STATEMENTS

     Certain matters discussed in this document are "forward looking
statements," intended to qualify for the safe harbors from liability established
by the Private Securities Legislation Reform Act of 1995.  These forward looking
statements can generally be identified as such because the context of the
statement will include words such as the

                                       3
<PAGE>
 
Company "believes," "anticipates," "expects," "estimates," or words of similar
import.  Similarly, statements that describe the Company's future plans,
objectives or goals are also forward looking statements.  Such forward looking
statements are subject to certain risks and uncertainties which are described in
close proximity to such statements and which could cause actual results to
differ materially from those anticipated as of the date of this report.
Shareholders, potential investors, and other readers are cautioned not to place
undue reliance on such forward-looking statements.  The forward-looking
statements included herein are only made as of the date of this report and the
Company undertakes no obligation to publicly update such forward-looking
statements to reflect subsequent events or circumstances.

LENDING ACTIVITIES

     General.   Home Federal originates loans primarily through its main office
located in Middlesboro, Kentucky.  The principal lending activity of the Bank is
the origination of conventional mortgage loans for the purpose of purchasing or
refinancing owner-occupied, one- to four-family residential properties in its
primary market areas.  Conventional mortgage loans are primarily adjustable-rate
mortgage loans with a small amount of fixed-rate mortgage loans which are not
insured or guaranteed by federal agencies.  The Bank does not originate Federal
Housing Administration-insured or Veterans Administration-insured loans.  The
Bank does originate consumer loans on a direct basis.  In addition, the Bank
also makes conventional mortgage loans for the purpose of constructing one- to
four-family residences and loans to construct commercial and multi-family real
estate.

     The Bank emphasizes the origination of adjustable-rate loans and short-term
loans in order to increase the interest rate sensitivity of its loan portfolio.
However, the Bank also continues to offer long-term, fixed-rate conventional
mortgage loans (25 year terms or less), originated for its portfolio.  For the
fiscal year ended June 30, 1998, fixed-rate mortgages comprised 19.8% of total
mortgage loans originated for the period (all of which had terms of 25 years or
less), while adjustable rate and short term (5 years or less) balloon loans
comprised 80.2% of total mortgage loans originated for the period.

                                       4
<PAGE>
 
ANALYSIS OF LOAN PORTFOLIO

     Set forth below is selected data relating to the composition of the Bank's
loan portfolio at the dates indicated.  As of June 30, 1998, the Bank had no
concentrations of loans exceeding 10% of total loans other than as disclosed
below.
<TABLE>
<CAPTION>
                                                                  At June 30,
                                                      -----------------------------------  
                                                             1998               1997       
                                                      ---------------    ----------------  
                                                       Amount      %      Amount      %    
                                                      --------  -----    --------  ------  
                                                             (Dollars in thousands)
<S>                                                   <C>       <C>      <C>       <C>
Real estate loans:
  Single and multi-family mortgage loans............  $ 94,153   78.45%  $ 86,095   79.92%
  Commercial real estate loans......................    10,411    8.67     10,096    9.37
  Real estate construction loans....................     8,636    7.20      5,091    4.73
                                                      --------  ------   --------  ------
    Total real estate loans.........................   113,200   94.32    101,282   94.02
                                                      --------  ------   --------  ------
 
Consumer loans:
  Loans on deposits.................................     1,995    1.66      1,964    1.82
  Home improvement loans............................     1,176     .98      1,306    1.21
  Automobile loans..................................     1,685    1.40        959     .89
  Other (1).........................................     1,617    1.35      1,493    1.39
                                                      --------  ------   --------  ------
    Total consumer loans............................     6,473    5.39      5,722    5.31
                                                      --------  ------   --------  ------
 
Commercial loans....................................       353     .29        723     .67
                                                      --------  ------   --------  ------
 
Total gross loans...................................   120,026  100.00%   107,727  100.00%
                                                      --------  ======   --------  ======
 
Less:
  Undisbursed portion of
    mortgage loans..................................     2,757              2,019
  Allowances for loan losses........................       973                710
  Unamortized discount and deferred loan fees, net..       125                 14
                                                      --------           --------
 
Total...............................................  $116,171           $104,984
                                                      ========           ========
 
-------------------------
</TABLE>
(1)  Includes home equity lines of credit.

                                       5
<PAGE>
 
     The following table sets forth certain information as of June 30, 1998
regarding the dollar amount of principal repayments becoming due during the
periods indicated for loans.  Demand loans, loans having no schedule of
repayments and no stated maturity, and overdrafts are reported as due in one
year or less.  The table below does not include any estimate of prepayments
which significantly shorten the average life of all mortgage loans and may cause
the Bank's actual repayment experience to differ from that shown below.
<TABLE>
<CAPTION>
 
                                  0-1 Year  1-5 Years   5-10 Years  Over 10 Years   Total
                                  --------  ---------   ----------  -------------  --------
                                                         (In thousands)
<S>                                 <C>       <C>         <C>          <C>        <C>
Real estate mortgage loans......    $3,659    $14,190     $24,454      $62,261     $104,564
Real estate construction loans..       548      2,746       4,904          438        8,636
Consumer loans (1)..............     3,446      2,661         291           75        6,473
Commercial loans................       205         49          99           --          353
                                    ------    -------     -------      -------     --------
 Total gross loans..............    $7,858    $19,646     $28,748      $62,774     $120,026
                                    ======    =======     =======      =======     ========
 
-------------------------
</TABLE>
(1)  Includes second mortgages and home equity lines of credit.


     The following table sets forth as of June 30, 1998 the dollar amount of all
the loans due after the year ending June 30, 1998 and distinguishes between
those with fixed interest rates and those with adjustable interest rates.
<TABLE>
<CAPTION>
 
                                  Predetermined    Floating or
                                      Rate       Adjustable Rates    Total
                                  -------------  ----------------  ---------
                                                  (In thousands)
<S>                               <C>            <C>               <C>
Real estate mortgage loans......     $16,830         $84,078        $100,905
Real estate construction loans..          --           8,088           8,088
Consumer loans..................       1,457           1,567           3,027
Commercial loans................          99              49             148
                                     -------         -------        --------
 Total gross loans..............     $18,386         $93,782        $112,168
                                     =======         =======        ========
 
</TABLE>

     One- to Four-Family Real Estate Lending.  The primary emphasis of the
Bank's lending activity is the origination of conventional loans secured by
owner occupied, one- to four-family residential properties.  The purchase price
for properties securing loans originated by the Bank in the Bank's lending area
has been between $30,000 and $305,000 and averaged $76,000 in fiscal year 1998.
Management believes that price range includes the majority of the single family
properties in the Bank's market area.  At June 30, 1998, $94.1 million, or
78.5%, of the Bank's gross loan portfolio consisted of loans secured by single
and multi-family residential real properties which were primarily owner-
occupied, single-family residences located in the Bank's market area.

     The Bank's conventional mortgage loan originations are generally for terms
of 10 to 30 years, amortized on a monthly basis, with principal and interest due
each month.  Residential real estate loans often remain outstanding for
significantly shorter periods than their contractual terms.  Borrowers may
refinance or prepay loans at their option without penalty.  Conventional
residential mortgage loans granted by the Bank customarily contain "due-on-sale"
clauses which permit the Bank to accelerate the indebtedness of the loan upon
transfer of ownership of the mortgaged property.  Due-on-sale clauses are an
important means of imposing assumption fees and increasing the rate on existing
mortgage loans during periods of rising interest rates and increasing the
turnover of mortgage loans in the Bank's portfolio.

     The Bank's lending policies generally limit the maximum loan-to-value ratio
on mortgage loans secured by owner-occupied properties to 81% and 95% of the
lesser of the appraised value or purchase price.  The maximum loan-to-value
ratio on mortgage loans secured by non-owner-occupied properties and/or used for
refinancing purposes is also

                                       6
<PAGE>
 
80%.  The Bank does originate some 81%-95% loan-to-value ratio loans.  Although
the Bank does not require private mortgage insurance on these loans, it charges
a higher effective interest rate on such loans to account for the additional
risk which 81%-95% loan-to-value ratio loans carry.

     Home Federal began originating conventional adjustable-rate residential
mortgage loans in the early 1980's and principally offers a variety of
adjustable-rate mortgage loans with rate adjustments indexed either to the
weekly average rate of U.S. Treasury securities adjusted to the relevant
maturity for the adjustment term, or the National Median Cost of Funds.  Home
Federal originated $28.7 million in adjustable-rate one-to-four family mortgage
loans during the year ended June 30, 1998, or 80.2%, of the mortgage loans
originated during the year, and such loans amounted to $78.1 million, or 65.07%,
of the Bank's gross loan portfolio at June 30, 1998.

     The retention of adjustable-rate mortgage loans in the Bank's portfolio
helps reduce the Bank's exposure to changes in interest rates.  However, there
are unquantifiable credit risks resulting from potential increased costs to the
borrower as a result of repricing of adjustable-rate mortgage loans.  It is
possible that during periods of rising interest rates, the risk of default on
adjustable-rate mortgage loans may increase due to the upward adjustment of
interest cost to the borrower.  Further, the adjustable-rate mortgages
originated by the Bank generally provide for initial rates of interest less than
the fully indexed rates which would prevail were the index used for pricing
applied initially.  These loans are subject to increased risk of delinquency or
default as the higher, fully-indexed rate of interest subsequently comes into
effect, replacing the lower initial rate.  Further, although adjustable-rate
mortgage loans allow the Bank to increase the sensitivity of its asset base to
change in interest rates, the extent of this interest sensitivity is limited by
the periodic and lifetime interest rate adjustment limitations.  Accordingly,
there can be no assurance that yields on the Bank's adjustable-rate mortgages
will adjust sufficiently to compensate for increases in the Bank's cost of
funds.

     Home Federal also originates conventional fixed-rate mortgage loans on one-
to-four family residential properties, all of which have a maximum term to
maturity of 15 years.  The Bank originates and holds its fixed-rate mortgage
loans in its portfolio as long-term investments.  Home Federal originated 
$7.1 million in fixed-rate one- to-four family mortgage loans with a maximum
maturity of 15 years during the year ended June 30, 1998, and such loans
amounted to $16.1 million, or 13.4%, of the Bank's gross loan portfolio at 
June 30, 1998. Such loans amounted to 19.8% of all mortgage loans originated
during fiscal 1998. All such loans were held as long-term investments, and none
were held for sale.

     Home Federal engages in a limited, but increasing amount of construction
lending, involving loans to qualified borrowers for construction of one- to-four
family residential properties.  These properties are primarily located in the
Bank's market area.  At June 30, 1998 the Bank's loan portfolio included 
$8.6 million of loans secured by properties under construction, all of which
were construction/permanent loans structured to become permanent loans upon the
completion of construction and none of which were interim construction loans
structured to be repaid in full upon completion of construction and receipt of
permanent financing. All construction loans are secured by a first lien on the
property under construction. Loan proceeds are disbursed in increments as
construction progresses and as inspections warrant. Construction/permanent loans
generally have adjustable interest rates and are underwritten in accordance with
the same terms and requirements as the Bank's permanent mortgages, except the
loans generally provide for disbursement in stages during a construction period
of up to six months, during which period the borrower is required to make
monthly payments of accrued interest on the outstanding loan balance. Interim
construction loans generally have fixed interest rates, terms of up to six
months and a maximum loan-to-value ratio of 80%. Borrowers must satisfy all
credit requirements which would apply to the Bank's permanent mortgage loan
financing for the subject property.

     Loans involving construction financing present a greater level of risk than
loans for the purchase of existing homes since collateral values and
construction costs can only be estimated at the time the loan is approved.  The
Bank has historically had a small amount of construction loans, thus limiting
risk in this area, however, as the level of construction lending increases, the
risk will correspondingly increase.

                                       7
<PAGE>
 
     Consumer Lending.  Consumer lending is a small but important part of Home
Federal's business.  Consumer loans generally have shorter terms to maturity or
repricing and higher interest rates than the long-term, adjustable-rate mortgage
loans that constitute a substantial part of the Bank's loan portfolio.  The
Bank's consumer loans primarily consist of savings account loans, automobile
loans, home equity loans and lines of credit, second mortgage loans and other
consumer loans secured by mortgages on residences.  The Bank also makes a
limited amount of unsecured loans.  At June 30, 1998, the Bank's consumer loans
totaled $6.5 million, or 5.4%, of the Bank's gross loan portfolio.
Approximately $2.0 million of these loans are secured by savings accounts.
Management expects to continue to aggressively promote consumer loans as part of
its strategy to provide a wide range of personal financial services to its
customers and as a means to enhance the interest rate sensitivity of the Bank's
interest-earning assets and the spread between its average loan yield and its
costs of funds.

     Home Federal makes automobile loans directly to the borrower.  Direct
automobile loans secured by new cars generally are limited to 90% of the
purchase price and have terms of up to 60 months.  Automobile loans secured by
used cars generally are limited to their loan value as published by the National
Automobile Dealers Association and terms of 24-60 months, depending on the age
of the automobile.  Collision insurance policies are required on all automobile
loans.  At June 30, 1998, the Bank had $1.4 million in automobile loans.

     Home Federal offers home equity lines of credit which are generally made on
the security of residences on which the Bank has a first mortgage.  Consumer
mortgage loans generally do not exceed 80% of the appraised value of the
residence (less the outstanding principal of the first mortgage).  The draw
period is limited to the first 10 years and the loans have monthly adjustable
interest rates indexed to the One Year Treasury Index (the maximum interest rate
is 18%).  At June 30, 1998, the Bank had $1.4 million disbursed under home
equity lines of credit and an additional $2.6 million of authorized but undrawn
home equity lines of credit.

     Home Federal makes savings account loans up to 90% of a depositor's savings
account balance.  The account must be pledged as collateral to secure the loan.
Savings account loans are payable on demand.  Interest is billed on a quarterly
basis.  Accrued but unpaid interest is added to the loan balance.  If the loan
balance rises to 98% of the savings account balance, the Bank sends a letter to
the customer requesting payment of the accrued interest, and if payment is not
made the Bank may demand payment of the full loan amount.

     Consumer loans entail greater risk than do residential mortgage loans,
particularly in the case of consumer loans which are unsecured or secured by
rapidly depreciable assets such as automobiles.  In such cases, any repossessed
collateral for a defaulted consumer loan may not provide an adequate source of
repayment of the outstanding loan balance as a result of the greater likelihood
of damage, loss or depreciation.  The remaining deficiency often does not
warrant further substantial collection efforts against the borrower.  In
addition, consumer loan collections are dependent on the borrower's continuing
financial stability, and thus are more likely to be adversely affected by job
loss, divorce, illness or personal bankruptcy.  Furthermore, the application of
various federal and state laws, including federal and state bankruptcy and
insolvency laws, may limit the amount which can be recovered on such loans.
Such loans may also give rise to claims and defenses by a consumer loan borrower
against an assignee of such loans such as the Bank, and a borrower may be able
to assert against such assignee claims and defenses which it has against the
seller of the underlying collateral.  Despite these risks, the Bank's level of
consumer loan delinquencies generally has been low.  No assurance can be given,
however, that the Bank's delinquency rate on consumer loans will continue to
remain low in the future.

     Commercial Lending.  As a federally chartered savings institution, the Bank
is authorized to invest up to 10% of its assets in commercial loans not secured
by real property.  Home Federal has only a limited amount of commercial loans
and does not actively pursue loans of this type.  At June 30, 1998, the Bank had
$353,000, or .29%, of its assets outstanding in commercial loans not secured by
real property.

     Commercial and Multi-Family Real Estate Lending.  Home Federal has
historically engaged in a limited amount of commercial and multi-family real
estate lending.  These types of lending can involve substantial risk.  The

                                       8
<PAGE>
 
Bank generally makes commercial and multi-family real estate loans available on
properties in its market area, with terms of 20 years or less, loan-to-value
ratios of 80% or less and adjustable rates of interest.  In addition, the Bank,
from time to time, purchases whole loans or participation interests in loans on
commercial and multi-family real estate located in Kentucky and Eastern
Tennessee.  See "Participation Interests in Loans."  Management does not
actively seek commercial or multi-family real estate lending opportunities and
applies conservative underwriting criteria to those applications which it does
consider.

     Home Federal's largest commercial real estate loans at June 30, 1998
consisted of: (i) loans with an outstanding balance of $1.3 million secured by a
hotel and restaurant development, (ii) a loan with an outstanding balance of
$946,000 secured by properties in a resort development in Campbell County
Tennessee, (iii) a loan with an outstanding balance of $878,000 secured by an
apartment complex in Campbell County Tennessee, and (iv) a loan with an
outstanding balance of $600,000 secured by a condominium development in
Tazewell, Tennessee.  All of these loans were being repaid on an amortized basis
and the borrowers have performed as agreed with the exception of the first loan
noted above.  (See "Non-Performing Loans and Other Problem Asset" for additional
information regarding this loan.)

     Loans secured by commercial real estate generally are larger and involve
greater risks than one- to-four family residential mortgage loans.  Because
payments on loans secured by such properties are often dependent on successful
operation or management of the properties, repayment of such loans may be
subject to a greater extent to adverse conditions in the real estate market or
the economy.  The Bank seeks to minimize these risks in a variety of ways,
including obtaining personal guarantees from the principals of the borrower and
reviewing the principal's financial condition, limiting the size of such loans
and strictly scrutinizing the financial condition of the borrower through the
review of financial statements, and establishing the quality of the collateral
and the effectiveness of the management of the property securing the loan.
Substantially all of the properties securing the Bank's commercial and multi-
family real estate loans are inspected by the Bank's lending personnel before
the loan is made.  The Bank also obtains appraisals on each property in
accordance with applicable regulations.  If such loans later become delinquent,
the Bank contacts and works with the borrower to resolve the delinquency or
initiates foreclosure proceedings.

     The Bank's self-imposed loan to one borrower limit is approximately 
$2.4 million at June 30, 1998. Savings institutions generally are subject to the
lending limits applicable to national banks. With certain limited exceptions,
the maximum amount that a savings institution or a national bank may lend to any
borrower (including certain related entities of the borrower) at one time may
not exceed 15% of the unimpaired capital and surplus of the institution, plus an
additional 10% of unimpaired capital and surplus for loans fully secured by
readily marketable collateral. Savings institutions are additionally authorized
to make loans to one borrower, for any purpose, in an amount not to exceed
$500,000 or, by order of the Director of OTS, in an amount not to exceed the
lesser of $30,000,000 or 30% of unimpaired capital and surplus to develop
residential housing, provided: (i) the purchase price of each single-family
dwelling in the development does not exceed $500,000; (ii) the savings
institution is in compliance with its fully phased-in capital requirements;
(iii) the loans comply with applicable loan-to-value requirements, and; (iv) the
aggregate amount of loans made under this authority does not exceed 15% of
unimpaired capital and surplus.

     Participation Interests in Loans.  Due to limited lending opportunities in
the Bank's immediate market area, the Bank, from time to time, has purchased
participation interests in loans on residential, commercial and multi-family
real estate located in Kentucky and Eastern Tennessee.  At June 30, 1998,
participation interests in loans totaled $3.9 million, or 3.3%, of the Bank's
gross loan portfolio.  Of this amount $1.7 million were secured by residential
properties and $2.2 million were secured by commercial or multi-family
properties.

     It is the Bank's policy to purchase participation interests in loans that
meet the Bank's underwriting standards on loans it originates directly.  The
Bank requires income and deposit verification to be provided on each borrower.
All loans must be documented, including an appraisal that substantiates the
value of the subject property at the time of origination of the loan.  The Bank
may, however, rely on the appraisal obtained by the financial institution
originating the loan.  Appraisals generally are substantiated with an inspection
of the properties by an officer of the Bank.  The Bank makes every effort to
purchase loans only from financially secure institutions.  There can be no
assurance that

                                       9
<PAGE>
 
a servicing financial institution will not experience financial difficulty which
may affect the Bank's ability to timely collect any principal and interest
payments, although the Bank, to date, has not experienced these types of
problems on the participation interests it has purchased.

     Loan Solicitation and Processing.  Loan originations are derived from a
number of sources.  Residential mortgage loan originations primarily come from
walk-in customers and referrals by realtors, depositors and borrowers.  The
Bank's loan solicitation program includes two loan officers on the road in the
Bank's market area.  These officers have regular realtor and builder routes.
Consumer and other loan originations emanate from many of the same sources as
for residential real estate loan originations as well as from consumer goods
dealers.  Real estate loans are originated by Home Federal's staff of loan
officers working in one of the Bank's offices.  Loan applications are taken in
each of the Bank's offices and then submitted to the Bank's main office for
processing and approval.  Applications for fixed-rate one-to-four family real
estate loans are underwritten and closed based on the Bank's own loan
guidelines.

     Upon receipt of a loan application from a prospective borrower, a credit
report and verifications are ordered to verify specific information relating to
the loan applicant's employment, income and credit standing.  An appraisal of
the real estate intended to secure the proposed loan is undertaken by either the
Bank's staff appraiser (for the vast majority of appraisals) or a fee appraiser
approved by the Bank.

     The Board of Directors of the Bank has the responsibility and authority for
general supervision over the loan policies of the Bank.  The Board has
established written lending policies for the Bank and has delegated to its Loan
Committee, which consists of the President, the Senior Lending Officer, and two
designated Directors, the authority to approve all mortgage loans up to
$500,000.  With respect to consumer loans, The President, Senior Lending Officer
and the Branch Manager of the New Tazewell and Harlan offices are authorized to
approve unsecured loans up to $15,000 and other lending officers are authorized
to approve unsecured loans from $5,000 to $10,000.

     Loan applicants are promptly notified of the decision of the Bank.
Interest rates on approved loans are subject to change if the loan is not funded
within 30 days after approval.  If an approved loan is not funded within 45
days, management contacts the applicant to determine the loan's status.  It has
been management's experience that substantially all approved loans are funded.

                                       10
<PAGE>
 
     Loan Originations, Purchases and Sales.   The following table sets forth
certain information with respect to the loan origination and purchase activity
of the Bank during the periods indicated.
<TABLE>
<CAPTION>
 
                                                For the Year Ended June 30,
                                               -----------------------------
                                                   1998             1997
                                               ------------     ------------      
                                                       (In thousands)
<S>                                             <C>               <C>
Loans originated:
  Conventional real estate loans:
    Construction loans:
      1-4 family residences.................    $ 4,823           $ 3,411
      Non-residential.......................        366             1,202
    Permanent loans:                                    
      Newly built 1-4 family................        189                --
      Previously occupied 1-4 family........     30,809            20,095
      Newly built 5 or more family..........         --                --
      Previously occupied 5 or more family..         --                --
      Non-residential.......................         --             2,118
      Land..................................      1,411             2,160
  Consumer loans............................      3,635             4,377
  Commercial loans..........................        562               571
                                                -------           -------
      Total.................................    $41,795           $33,934
                                                =======           =======
Loans purchased.............................    $    --           $   750
                                                =======           =======
Loans sold..................................    $    --           $ 1,500
                                                =======           =======
 
</TABLE>

     During fiscal 1998, the Bank did not purchase any loans.  During fiscal
1997, the Bank purchased a $750,000 loan secured by a multi-family complex in
Murfreesboro, Tennessee.  No loans were sold in fiscal 1998.  Loans sold in
fiscal 1997 include two commercial real estate loans of $750,000 each, secured
by a hotel, restaurant and other properties.

     Interest Rates and Loan Fees.  Interest rates charged by the Bank on
mortgage loans are primarily determined by competitive loan rates offered in its
market area.  Mortgage loan rates reflect factors such as general interest rate
levels, the supply of money available to the savings industry and the demand for
such loans.  These factors are in turn affected by general economic conditions,
the monetary policies of the Federal government, including the Board of
Governors of the Federal Reserve System (the "Federal Reserve Board"), the
general supply of money in the economy, tax policies and governmental budget
matters.

     In addition to interest earned on loans, Home Federal receives fees for
servicing loans for others.  Loan servicing fees usually are charged as a
percentage (generally 1/4%) of the balance of the loans being serviced.  At 
June 30, 1998 the Bank was servicing $2.8 million of loans for others, and loan
service fee income was considered immaterial for 1996, 1997 and 1998. In
addition to loan servicing fees, the Bank receives fees in connection with loan
commitments and originations, loan modifications, late payments, changes of
property ownership and for miscellaneous services related to its loans.  Income
from these activities varies from period to period with the volume and type of
loans originated, sold and purchased, which in turn is dependent on prevailing
mortgage interest rates and their effect on the demand for loans in the markets
served by the Bank.

                                       11
<PAGE>
 
     Asset Classification and Allowance for Loan Losses.  Federal regulations
require savings associations to review their assets on a regular basis and to
classify them as "substandard," "doubtful" or "loss," if warranted.  Assets
classified as substandard or doubtful require the institution to establish
general allowances for loan losses.  If an asset or portion thereof is
classified loss, the insured institution must either establish specified
allowances for loan losses in the amount of 100% of the portion of the asset
classified loss, or charge off such amount.  An asset which does not currently
warrant classification but which possesses weaknesses or deficiencies deserving
close attention is required to be designated as "special mention."  Currently,
general loss allowances established to cover possible losses related to assets
classified substandard or doubtful may be included in determining an
institution's regulatory capital, while specific valuation allowances for loan
losses do not qualify as regulatory capital.  See "Regulation -- Regulatory
Capital Requirements."  The Bank has determined that at June 30, 1998 it had
$1.3 million in assets classified as substandard, $574,000  in assets classified
as doubtful and $7,000 in assets classified as loss.  In addition, the Bank had
$132,000 in assets designated as special mention.   Depending on their future
performance, it is possible that these loans might be required to be classified
in future periods.  For additional information, see "Non-Performing Loans and
Other Problem Assets."

     The Bank recognizes that credit losses will be experienced and that the
risk of loss will vary with, among other things, the type of loan being made,
the creditworthiness of the borrower over the term of the loan, general economic
conditions and, in the case of a secured loan, the quality of the security for
the loan.  It is management's policy to maintain an adequate allowance for loan
losses based on, among other things, the Bank's and the industry's historical
loan loss experience, evaluation of economic conditions and regular reviews of
delinquencies and loan portfolio quality.  The Bank increases its allowance for
loan losses by charging provisions for possible loan losses against the Bank's
income.

     General allowances are made pursuant to management's assessment of risk in
the Bank's loan portfolio as a whole.  Specific allowances are provided for
individual loans when ultimate collection is considered questionable by
management after reviewing the current status of loans which are contractually
past due and considering the net realizable value of the security for the loan.
General allowances are included in calculating the Bank's risk-based capital,
while specific allowances are not so included.  Management continues to actively
monitor the Bank's asset quality and to charge off loans against the allowance
for loan losses when appropriate or to provide specific loss reserves when
necessary.  Although management believes it uses the best information available
to make determinations with respect to the allowance for loan losses, future
adjustments may be necessary if economic conditions differ substantially from
the economic conditions in the assumptions used in making the initial
determinations.

     The Bank recorded a provision for loan loss of $274,000 in fiscal 1998 and
$138,000 in fiscal 1997, primarily due to the dollar amount of commercial real
estate loans in the Bank's loan portfolio.  Management also reviews individual
loans for which full collectibility may not be reasonably assured and considers,
among other matters, the fair value of the underlying collateral.  While the
Bank believes it has established its existing allowances for loan losses in
accordance with generally accepted accounting principles, there can be no
assurance that changes in the Bank's loan portfolio or in economic conditions
would not require the Bank to significantly increase its allowance for loan
losses, thereby negatively effecting the Bank's financial condition and
earnings.

                                       12
<PAGE>
 
     The following table sets forth an analysis of the Bank's allowance for loan
losses for the periods indicated.

<TABLE>
<CAPTION>
 
                                           Year Ended June 30,
                                           --------------------
                                             1998        1997
                                           -------     --------           
                                          (Dollars in Thousands)
<S>                                        <C>         <C>

 
Balance at Beginning of Period...........  $ 710         $ 671
                                           -----         -----
                                                     
Loan charged-offs:                                   
  Real Estate:                                       
    Residential..........................     --            --
    Commercial...........................     --           (99)
  Consumer...............................     11            (3)
  Commercial.............................     --            --
                                           -----         -----
Total charge-offs........................     11          (102)
                                           -----         -----
                                                     
Recoveries:                                          
  Real Estate:                                       
    Residential..........................     --             3
    Commercial...........................     --            --
  Consumer...............................     --            --
  Commercial.............................     --            --
                                           -----         -----
                                                     
Total Recoveries.........................     --             3
                                           -----         -----
Net loan recoveries (chargeoffs).........     --           (99)
                                           -----         -----
Provision for Loan Losses................    274           138
                                           -----         -----
                                                     
Balance at end of period.................  $ 973         $ 710
                                           =====         =====
                                                     
Ratio of allowance for losses to                     
  gross loans receivable.................    .83%          .67%
                                           =====         =====
                                                     
Ratio of net loan chargeoffs to average              
  loans outstanding during the period....    .01%          .10%
                                           =====         =====
</TABLE>

                                       13
<PAGE>
 
     The following table sets forth the breakdown of the allowance for loan
losses by loan category at the dates indicated.  Management believes that the
allowance can be allocated by category only on an approximate basis.  The
allocation of the allowance to each category is not necessarily indicative of
future losses and does not restrict the use of the allowance to absorb losses in
any category.
<TABLE>
<CAPTION>
 
 
                                                        Year Ended June 30,
                              ------------------------------------------------------------------------
                                            1998                                   1997
                              ---------------------------------     ----------------------------------
                                         % of Loans                             % of Loans
                                          in Each       % of                     in Each        % of
                                          Category   Allowance                   Category     Allowance
                                          to Total    to Total                  to Total      to Total
                               Amount   Gross Loans     Loans        Amount    Gross Loans     Loans
                              --------  ------------  ---------     ---------  ------------  ----------
                                                    (Dollars in thousands)
<S>                           <C>       <C>           <C>          <C>        <C>            <C>
                                                             
Residential and commercial                                   
  real estate loans.........    $970       94.31%       .81%          $707        94.02%        .69%
Consumer loans..............       3        5.39         --              3         5.31         .05
Commercial loans............      --         .30         --             --          .67          --
                                ----      ------                    ------      -------
   Total allowance for                                       
     loan losses............    $973      100.00%                     $710       100.00%
                                ====      ======                    ======      =======
 
</TABLE>

     Non-Performing Loans and Other Problem Assets.  Management reviews the
credit quality of the Bank's loans on a regular basis.  After residential
mortgage loans become past due more than 90 days, the Bank generally establishes
an allowance for uncollectible interest for the amount by which the principal
balance and uncollected interest exceeds 90% of the appraised value of the
property.  Commercial and multi-family real estate loans generally are placed on
non-accrual status if the borrower is placed in bankruptcy proceedings, or
management concludes that payment in full is not likely.  The Bank has had a
favorable loan loss history, and has not charged off any residential real estate
loans during fiscal 1998 or 1997.  During fiscal 1997, the Bank charged off
$99,000 of a participation loan secured by a food store in Nicholasville,
Kentucky.  The property was sold at public auction as the result of an agreement
between the borrowers and the participating lenders.  In accordance with the
agreement, the Bank has no further recourse to recover the deficiency.  Consumer
and commercial loans generally are charged off, or any expected loss is reserved
for, after they become more than 90 days past due.  The Bank accrues interest on
delinquent loans past due more than 90 days without establishing a reserve when
management concludes such action is warranted, such as in the event the loan is
exceptionally well collateralized or the borrower establishes the temporary
nature of the delinquency.  Loans are charged off when management concludes that
they are uncollectible.  See also "Nature of Operations and Summary of
Significant Accounting Policies" included in the Notes to Consolidated Financial
Statements in the Annual Report filed as Exhibit 13 to this report.

     Real estate acquired by the Bank as a result of foreclosure is classified
as real estate owned until such time as it is sold.  When such property is
acquired, it is recorded at the lower of the unpaid principal balance or its
fair market value (less estimated selling cost at the date of foreclosure).  Any
required write-down of the loan to its fair market value upon foreclosure is
charged against the allowance for loan losses.

                                       14
<PAGE>
 
     The following table sets forth information with respect to the Bank's
nonperforming assets at the dates indicated.   No loans were recorded as
restructured loans within the meaning of Statement of Financial Accounting
Standards No. 15, at the dates indicated.
<TABLE>
<CAPTION>
 
                                                            At June 30,
                                                      -----------------------
                                                       1998            1997
                                                      -------        --------   
                                                      (Dollars in thousands)
<S>                                                  <C>              <C>
 
    Loans accounted for on a nonaccrual basis (1)..    $  --           $  --
                                                       -----           -----
    Accruing loans which are contractually
      past due 90 days or more: (1)
      Real estate..................................    $ 677           $ 365
      Consumer.....................................       40               3
      Commercial...................................       --              --
                                                       -----           -----
      Total of nonaccrual and 90 days
        or more past due loans.....................    $ 717           $ 368
                                                       -----           -----
 
    Real estate owned..............................       --              58
                                                       -----           -----
      Total nonperforming assets...................    $ 717           $ 426
                                                       =====           =====
    Nonaccrual and 90 days or more past due
      loans as a percentage of total loans, net....      .62%            .41%
                                                       =====           =====
    Nonaccrual and 90 days or more past due
      loans as a percentage of total assets........      .41%            .23%
                                                       =====           =====
    Nonperforming assets as a percentage
      total assets.................................      .41%            .27%
                                                       =====           =====
 
-------------------------
</TABLE>
(1)  Interest on delinquent loans is accrued to income to the extent considered
     collectible. Nonaccrual loans did not have a material effect on the Bank's
     interest income for the years ended June 30, 1998.


     As of June 30, 1998, Home Federal had a total of $556,000 in 11 single
family loans classified as "substandard."  The balances of these loans ranged
from $5,000 to $262,000.  The risk of loss in the remaining loans, in
Management's opinion, at this time, is not significant.  As of June 30, 1998,
Home Federal had $11,000 in consumer loans classified and $121,000 in four
single family residential loans classified as "special mention."

     In addition, the Bank had five commercial real estate loans to one borrower
totaling $1.3 million, of which $699,000 had been classified as "substandard"
and $572,000 had been classified as "doubtful."  The largest property, a hotel-
restaurant operation has suffered severe cash flow problems and the borrower is
actively seeking alternative financing, which would payoff these loans.  The
borrower has informed Management that this new financing is scheduled to occur
in mid October.  The loans were, as of September 30, 1998, six months past due
and foreclosure on the properties has been initiated.  Management believes that
these loans have been adequately classified and reserved for, but continues to
monitor them as to their collectibility and as to any possible losses the Bank
could incur, or additional reserves that may need to be established.

     As of June 30, 1998, Home Federal had no real estate owned.

     Finally, at June 30, 1998, the Bank had no other loans which were not
classified as non-accrual, past due 90 days or more or restructured but where
known information about possible credit problems of borrowers caused management
to have serious doubts as to the ability of the borrowers to comply with present
loan repayment terms and could result in future disclosure as non-accrual, 90
days past due or restructured.

                                       15
<PAGE>
 
INVESTMENT ACTIVITIES

     Home Federal is required under federal regulations to maintain a minimum
amount of liquid assets, which can be invested in specified short-term
securities, and is also permitted to make certain other investments.  See
"Regulation" and "Management's Discussion and Analysis of Financial Condition
and Results of Operations -- Liquidity and Capital Resources" in the Annual
Report.  It has generally been Home Federal's policy to maintain a liquidity
portfolio in excess of the amount required to satisfy regulatory requirements,
and the Bank's liquidity ratio of 26.2% at June 30, 1998 exceeded the 4%
regulatory liquidity requirement.  Liquidity levels may be increased or
decreased depending upon the yields on investment alternatives, management's
judgment as to the attractiveness of the yields then available in relation to
other opportunities, its expectations of the level of yield that will be
available in the future and its projections as to the short-term demand for
funds to be used in the Bank's loan origination and other activities.

     The general objectives of Home Federal's investment policy are to 
(i) protect Home Federal's depositor resources, (ii) maintain liquidity levels
to meet the operational needs of the Bank and applicable regulatory
requirements, (iii) reduce credit risk by investing in high quality, diverse
investments, (iv) serve as a hedge against significant interest rate shifts, 
(v) contribute to earnings in a stable and dependable manner without
compromising the goals of liquidity and safety, and (vi) provide collateral for
pledging needs. The Bank's investment activities are conducted by the Investment
Committee and supervised by the Board of Directors. An investment policy has
been adopted by the Board which provides for maintenance of the investment
portfolio for the purpose of providing earnings and ensuring a minimum liquidity
reserve. In accordance with the investment policy, management has primarily
invested in U.S. Treasury securities backed by the full faith and credit of the
United States and government agency securities, mortgage-backed securities
issued by FHLMC, FNMA, or GNMA, federal funds sold, and federally insured
interest-bearing deposits in other financial institutions. General obligation
and bank qualified bonds of municipalities within the market areas served by the
Bank and which are considered to possess acceptable credit and limited default
risk are also considered for investment.

     The Board of Directors of the Bank has authorized the existence of a
trading account in an amount not to exceed 8% of total assets for the purpose of
taking advantage of favorable short-term market conditions.  The Bank's
investment policy specifies that securities traded within this account must be
U.S. Treasury or agency obligations.  Securities in the trading account are
marked to market on a monthly basis.  During the year ended June 30, 1998, there
was no trading activity.  At June 30, 1998, there were no securities held in the
Bank's trading account.

     The Board of Directors of the Company has authorized the existence of a
trading account in an amount not to exceed $1.0 million for purpose of investing
in common stocks of publicly traded thrifts which are considered to be
undervalued.  The Company had $835,000 invested in common stock of publicly held
thrift institutions at June 30, 1998.

                                       16
<PAGE>
 
     The Bank, in accordance with generally accepted accounting principles,
reports its investment securities, available for sale, at current market value,
with unrealized gains or losses, net of tax effect, adjusted through equity and
realized gains or losses in income when securities are sold.  Investment
securities, held to maturity, are reported at cost as adjusted for unaccreted
discounts and unamortized premiums.  For more information, see Note 2 of Notes
to Consolidated Financial Statements.

     The following table sets forth the carrying value of the Bank's investment
securities at the dates indicated.
<TABLE>
<CAPTION>
 
                                                       At June 30,
                                                  --------------------
                                                    1998         1997
                                                  -------      -------
                                                      (In thousands)
<S>                                               <C>          <C>
Investment securities, available for sale:                
  U.S. Treasury and Federal Agency obligations... $18,238      $17,533
                                                  -------      -------
                                                          
Total investment securities, available for sale.. $18,238      $17,533
                                                  -------      -------
                                                          
Investment securities, held to maturity:                  
  U.S. Treasury and Federal Agency obligations... $ 6,497      $ 9,515
                                                  -------      -------
                                                          
Total investment securities, held to maturity.... $ 6,497      $ 9,515
                                                  -------      -------
                                                  
Total investment securities, available for        
  sale and held to maturity...................... $24,735      $27,048
                                                  =======      =======
</TABLE>

                                       17
<PAGE>
 
     The following table sets forth the scheduled maturities, amortized cost,
average yields, carrying values and market values for the Bank's investment
securities, excluding FHLB of Cincinnati capital stock at June 30, 1998.
<TABLE>
<CAPTION>
 
                                                              At June 30, 1998
                             -------------------------------------------------------------------------------------
                              One Year or Less       One to Five Years    Five to Ten Years    More than Ten Years
                             -------------------    ------------------   -------------------   -------------------
                             Amortized   Average    Amortized  Average   Amortized   Average   Amortized   Average   
                               Cost       Yield       Cost      Yield      Cost       Yield      Cost       Yield 
                             ---------   -------    ---------  -------   ---------   -------   ---------   -------
                                                           (Dollars in thousands)
<S>                          <C>        <C>       <C>          <C>      <C>         <C>        <C>        <C>      
Investment securities,               
 available for sale:                 
  U.S. Treasury and Federal          
   Agency obligations......     $278      6.30%     $10,479     6.42%   $  6,825      6.61%    $  500      6.99%
                             -------               ---------            --------               ------
    Total investment
     securities,
     available for sale....      278      6.30       10,479     6.42       6,825      6.61        500      6.99
                             -------               ---------            --------               ------
Investment securities,
 held to maturity:
  U.S. Treasury and Federal
   Agency obligations......       --        --        1,500     5.85       4,497      6.70        500      6.99
                             -------              ---------             --------               ------
    Total investment
     securities,
     held to maturity......       --        --        1,500     5.85       4,497      6.70        500      6.99
                             -------              ---------             --------               ------
    Total investment
     securities,
     available for sale and
     held to maturity......     $278      6.30%     $11,979     6.35%   $ 11,322      6.65%    $1,000      6.99%
                             =======              =========             ========               ======

<CAPTION>
                                           At June 30, 1998
                               --------------------------------------------
                                       Total Investment Portfolio
                               --------------------------------------------
                               Amortized    Carrying     Market     Average
                                 Cost        Value       Value      Yield
                               ----------  ---------    ---------  -------- 
                                        (Dollars in thousands)
<S>                            <C>         <C>         <C>          <C>       
Investment securities,               
 available for sale:                 
  U.S. Treasury and Federal          
   Agency obligations......     $  18,082  $  18,238   $  18,238     6.50%
                                ---------  ---------   ---------
    Total investment
     securities,
     available for sale....        18,082     18,238      18,238     6.50
                                ---------  ---------   ---------
Investment securities,
 held to maturity:
  U.S. Treasury and Federal
   Agency obligations......         6,497      6,497       6,533     6.53
                                ---------  ---------   ---------
    Total investment
     securities,
     held to maturity......         6,497      6,497       6,533     6.53
                                ---------  ---------   ---------
    Total investment
     securities,
     available for sale and
     held to maturity......     $  24,579  $  24,735   $  24,771     6.50%
                                =========  ==========  =========
</TABLE>
---------------
(1)       The average yield on the municipal has been computed on a tax 
          equivalent basis using an effective tax rate of 34%.


                                       18
<PAGE>
 
MORTGAGE-BACKED SECURITIES ACTIVITIES
                                       
     In accordance with Home Federal's investment policy, management invests in
mortgage-backed securities issued by the Federal Home Loan Mortgage Corporation
("FHLMC"), the Federal National Mortgage Association ("FNMA") and the Government
National Mortgage Association ("GNMA").
     
     The Bank, in accordance with generally accepted accounting principles,
reports its mortgage-backed securities, available for sale, at current market
value, with unrealized gains or losses, net of tax effect, adjusted through
equity and realized gains or losses in income when securities are sold.
Mortgage-backed securities, held to maturity, are reported at cost as adjusted
for unaccreted discounts and unamortized premiums.  For more information, see
Note 2 of Notes to Consolidated Financial Statements.

     The following table sets forth the composition of the Bank's mortgage-
backed securities portfolio at the dates indicated.

<TABLE>
<CAPTION>
 
                                                                  At June 30,
                                                       ----------------------------------- 
                                                             1998               1997       
                                                       -----------------  ---------------- 
                                                        Amount     %       Amount      %   
                                                       -------  -------   -------  ------- 
                                                               (Dollars in thousands) 
<S>                                                    <C>        <C>     <C>        <C>
Mortgage-backed securities, available for sale:
 FHLMC...........................................      $ 1,375     6.05%  $   368     2.08%
 FNMA............................................        3,912    17.22     6,102    33.40
 GNMA............................................        3,380    14.88     1,110     6.07
                                                       -------   ------   -------   ------
Total mortgage-backed securities
 available for sale..............................        8,667    38.15   $ 7,580    41.48
                                                       -------   ------   -------   ------
Mortgage-backed securities, held to maturity:
 FHLMC...........................................          581     2.56   $   247     1.35
 FNMA............................................        9,957    43.83    10,442    57.15
 GNMA............................................        3,512    15.46         3      .02
                                                       -------   ------   -------   ------
Total mortgage-backed securities,
 held to maturity................................       14,050    61.85   $10,692    58.52%
                                                       -------   ------   -------   ------
Total mortgage-backed securities, available
 for sale and held to maturity...................      $22,717   100.00%  $18,272   100.00%
                                                       =======   ======   =======   ======
</TABLE>

                                       19
<PAGE>
 
     The following table sets forth the scheduled maturities, amortized cost,
weighted average yields, carrying values and market values for the Bank's
mortgage-backed securities at June 30, 1998.  Scheduled maturities will differ
from contractual maturities due to repayments and because borrowers may have the
right to call or prepay obligations with or without prepayment penalties.  The
following table does not take into consideration the effects of scheduled
repayments or the effects of possible prepayments.

<TABLE>
<CAPTION>
 
                                                                At June 30, 1998
                              -----------------------------------------------------------------------------------
                                One Year or Less    One to Five Years    Five to Ten Years    More than Ten Years
                              -------------------  -------------------  --------------------  -------------------
                              Amortized  Average   Amortized  Average   Amortized   Average   Amortized  Average 
                                Cost      Yield      Cost      Yield      Cost       Yield      Cost      Yield  
                              ---------  --------  ---------  --------  ---------   --------  ---------  --------
                                                            (Dollars in thousands)             
<S>                          <C>        <C>       <C>        <C>       <C>        <C>       <C>        <C>     
Mortgage-backed securities,                                                                                    
 available-for-sale:                                                                                           
 FHLMC.....................  $      --       -- %    $  604     6.18%  $     294     6.01%    $   474     6.36%
 FNMA......................         --       --       2,452     6.03          --       --       1,430     6.67 
 GNMA......................         --       --          --       --          --       --       3,369     6.73 
                             ---------               ------            ---------              -------          
  Total mortgage-backed                                                                                        
   securities,                                                                                                 
    available-for-sale.....         --       --       3,066     6.06         294     6.01       5,273     6.68 
                                                                                                               
Mortgage-backed securities,                                                                                    
 held to maturity:                                                                                             
 FHLMC.....................  $      --       -- %    $  425     5.90%  $      --       --%    $   156     6.58%
 FNMA......................         --       --       4,373     6.19       1,550     6.54       4,034     6.11 
 GNMA......................         --       --           1      7.5          --       --       3,511     6.68 
                             ---------               ------            ---------              -------          
  Total mortgage-backed                                                                                        
   securities,                                                                                                 
    held-to-maturity.......  $      --       -- %    $4,799     6.16%     $1,550     6.54%    $ 7,701     6.39%
                             ---------               ------            ---------              -------          
  Total mortgage-backed                                                                                        
   securities,                                                                                                 
    available-for-sale                                                                                         
     and held-to-maturity..  $      --       -- %    $7,865     6.12%     $1,844     6.46%    $12,974     6.51%
                             =========               ======            =========              =======          



<CAPTION>
                                       At June 30, 1998
                                ------------------------------
                                       Total Mortgage-
                                  Backed Securities Portfolio
                                -------------------------------
                                Amortized    Market     Average
                                   Cost      Value      Yield
                                ---------    -------    -------
                                    (Dollars in thousands)
<S>                             <C>      <C>         <C>
Mortgage-backed securities,  
 available-for-sale:                                          
 FHLMC.....................      $ 1,372    $ 1,375      6.21%
 FNMA......................        3,892      3,912      6.27 
 GNMA......................        3,369      3,380      6.73 
                                 -------    -------           
  Total mortgage-backed                                       
   securities,                                                
    available-for-sale.....        8,633      8,667      6.44 

Mortgage-backed securities,                                   
 held to maturity:                                            
 FHLMC.....................      $   581    $   577      6.08%
 FNMA......................        9,957      9,995      6.21 
 GNMA......................        3,512      3,520      6.68 
  Total mortgage-backed          -------    -------           
   securities,                                                
    held-to-maturity.......      $14,050    $14,092      6.34%
  Total mortgage-backed          -------    -------           
   securities,                                                
    available-for-sale                                        
     and held-to-maturity..      $22,683    $22,759      6.37%
                                 =======    =======   
</TABLE>    
                                       20
<PAGE>
 
DEPOSIT ACTIVITY AND OTHER SOURCES OF FUNDS

   GENERAL.  Deposits are a significant source of the Bank's funds for lending
and other investment purposes.  In addition to deposits, Home Federal derives
funds from loan principal repayments and interest payments and maturing
investment securities.  Loan repayments and interest payments are a relatively
stable source of funds, while deposit inflows and outflows are significantly
influenced by general interest rates and money market conditions.  Borrowings
may be used on a short-term basis to compensate for reductions in the
availability of funds from other sources, or on a longer term basis for general
business purposes.

   DEPOSITS.  Deposits are attracted principally from within the Bank's primary
market area through the offering of a variety of deposit instruments, including
passbook and statement accounts and certificates of deposit.  Deposit account
terms vary, principally on the basis of the minimum balance required, the time
periods the funds must remain on deposit and the interest rate.  The Bank also
offers individual retirement accounts ("IRAs") and Keogh Plans.

   The Bank's policies are designed primarily to attract deposits from local
residents through its branch network rather than to solicit deposits from areas
outside its primary market.  The Bank does not accept deposits from brokers due
to the volatility and rate sensitivity of such deposits.   Interest rates paid,
maturity terms, service fees and withdrawal penalties are established by the
Bank on a periodic basis.  Determination of rates and terms are predicated upon
funds acquisition and liquidity requirements, rates paid by competitors, growth
goals and federal regulations.

     The following table sets forth the change in dollar amount of deposits in
the various types of accounts offered by the Bank between the dates indicated.
<TABLE>
<CAPTION>
 
                                Balance at                         Balance at
                                 June 30,     % of      Increase    June 30,     % of
                                   1998     Deposits   (Decrease)     1997     Deposits
                                ----------  ---------  ----------  ----------  ---------
                                               (Dollars in thousands)
<S>                           <C>         <C>        <C>         <C>         <C>
 
NOW checking accounts.......    $ 11,554      7.97%    $ 1,616     $  9,938      7.46%
Super NOW accounts..........         474       .33        (176)         650       .49
Passbook accounts...........       8,836      6.10        (607)       9,443      7.09
Money market plus accounts..         425       .29        (180)         605       .46
3-6 month certificates......      14,826     10.23       5,791        9,035      6.78
12 month certificates.......      29,510     20.37      11,418       18,092     13.58
18-48 months certificates...      70,296     48.53      (6,777)      77,073     57.86
60-96 month certificates....       8,960      6.18         593        8,367      6.28
                                --------    ------     -------     --------    ------
    Total...................    $144,881    100.00 %   $11,678     $133,203    100.00%
                                ========    ======     =======     ========    ======
</TABLE>

                                       21
<PAGE>
 
     The following table sets forth the average balances and interest rates for
the Bank's deposit accounts by type of deposit for the periods indicated.

<TABLE>
<CAPTION>
                                       Year Ended June 30,
                             ---------------------------------------
                                    1998                1997
                             ------------------  -------------------
                             Average    Average    Average   Average
                             Balance      Rate     Balance    Rate
                             --------   -------  ---------  --------
                                     (Dollars in thousands)
<S>                          <C>       <C>        <C>          <C>
NOW and money market                            
 deposit accounts..........  $ 11,823     2.18%   $ 11,666     2.14%
Passbook accounts..........     9,140     2.72       9,868     2.71
Certificates...............   116,570     5.32     110,440     5.33
                             --------             --------
  Total....................  $137,533     4.88    $131,974     4.85
                             ========             ========
</TABLE>

     The following table sets forth the time deposits in the Bank classified by
rates as of the dates indicated.

<TABLE> 
<CAPTION>
                                                             At June 30,
                                                        --------------------          
                                                           1998       1997
                                                        ----------  --------
                                                           (In thousands)
          <S>                                            <C>       <C>
          3.01 - 4.00%.................................  $  2,287  $  3,093
          4.01 - 5.00%.................................    22,315    38,099
          5.01 - 6.00%.................................    80,730    63,948
          6.01 - 7.00%.................................    18,053     6,962
          7.01 - 8.00%.................................       207       465
                                                         --------  --------
             Total.....................................  $123,592  $112,567
                                                         ========  ========
</TABLE>

     The following table sets forth the amount and maturities of certificates at
June 30, 1998.

<TABLE>
<CAPTION>
 
                                                     Amount Due
                                   --------------------------------------------------
                                   One Year                         After
      Rate                         or Less   1-2 Years   2-3 Years  3 Years    Total
---------------                    --------  ---------   ---------  -------  --------
                                                    (In thousands)
<S>                                <C>       <C>        <C>        <C>      <C>
                
3.01 - 4.00%....................... $ 2,279    $     6     $    2    $   --   $  2,287
4.01 - 5.00%.......................  21,234      1,059         --        22     22,315
5.01 - 6.00%.......................  45,647     31,834      1,294     1,955     80,730
6.01 - 7.00%.......................  13,495      1,546        287     2,725     18,053
7.01 - 8.00%.......................      14        180         --        13        207
                                    -------    -------     ------    ------   --------
    Total.......................... $82,669    $34,625     $1,583    $4,715   $123,592
                                    =======    =======     ======    ======   ========
</TABLE>

                                       22
<PAGE>
 
     The following table indicates the amount of the Bank's certificates of
deposit of $100,000 or more by time remaining until maturity as of June 30,
1998.  Most of the Bank's deposits of over $100,000 come from individual
depositors in the Bank's market area.

<TABLE>
<CAPTION>
                                                         Certificates
              Maturity Period                             of Deposit
              ---------------                           -------------
                                                        (In thousands)
           <S>                                              <C>
                                               
           Three months or less...........................  $ 7,854
           Three through six months.......................    6,657
           Six through twelve months......................   10,991
           Over twelve months.............................    9,679
                                                            -------
                Total.....................................  $35,181
                                                            =======
</TABLE>

     Management attributes the net increase in deposits for the year ended 
June 30, 1998 to general economic conditions and competition in the local
market. The Bank does not offer premiums for deposits, and in the past has not
offered interest rates on deposits which exceed the average rates paid by other
financial institutions in its market area.  Due to aggressive competition, the
Bank has recently instituted promotions offering higher rates on deposits to
maintain its market share.  Management anticipates that this trend will continue
over the next twelve months.

     BORROWINGS.   Savings deposits historically have been the primary source of
funds for the Bank's lending and investment activities and for its general
business activities.  The Bank is authorized, however, to use advances from the
FHLB of Cincinnati to supplement its supply of lendable funds and to meet
deposit withdrawal requirements.  In February 1991, the Bank borrowed $1,000,000
from the FHLB of Cincinnati.  The advance, which bears interest at a fixed-rate
of 8.05%, is payable in monthly installments of principal and interest totaling
$9,585.  The advance is for a term of 15 years, with the final payment due in
January 2006.  From time to time, the Bank uses short-term advances as a source
of funding.  In 1998 and 1997, the Company had available a 90-day revolving line
of credit up to a maximum of $13,000,000 and $10,000,000, respectively.  The
line of credit bears interest at a daily variable rate which is set by the
Federal Home Loan Bank.  At June 30, 1998, the Company had drawn $6.5 million on
the line of credit.  The highest amount drawn against the line during fiscal
1998 was $8.5 million which occurred in September 1997.  The weighted average
balance outstanding during fiscal 1998 was $8.1 million at a weighted average
rate of 5.08%.  All of the advances are collateralized by FHLB stock and single
family first mortgage loans with aggregate principal balances totaling 150% of
the outstanding amount of advances.

     The FHLB of Cincinnati functions as a central reserve bank providing credit
for savings institutions and certain other member financial institutions.  As a
member, Home Federal is required to own capital stock in the FHLB and is
authorized to apply for advances on the security of such stock and certain of
its home mortgages and other assets (principally, securities which are
obligations of, or guaranteed by, the United States) provided certain standards
related to creditworthiness have been met.

SUBSIDIARY ACTIVITIES

     As a federally chartered savings bank, Home Federal is permitted to invest
an amount equal to 2% of its assets in subsidiaries with an additional
investment of 1% of assets where such investment serves primarily community,
inner-city, and community development purposes.  Under such limitations, as of
June 30, 1998 Home Federal was authorized to invest up to approximately $3.5
million in the stock of or loans to subsidiaries including the additional 1%
investment for community inner-city and community development purposes.
Institutions meeting regulatory capital requirements, which Home Federal
currently does, may invest up to 50% of their regulatory capital in conforming
first mortgage loans to subsidiaries in which they own 10% or more of the
capital stock.

                                       23
<PAGE>
 
     The Bank's only subsidiary is Home Service Corporation in which its
investment was $1.8 million at June 30, 1998.  Home Service Corporation's
principal activity is that of ownership and rental of Home Federal's Main Office
Building in Middlesboro, Kentucky and a branch office in New Tazewell,
Tennessee.  Home Service Corporation also owns and rents two other properties to
unrelated parties.  These properties are contiguous to Home Federal's main
office and being held for future expansion.

     SAIF-insured savings institutions, such as the Bank, are required to give
the Director of the OTS 30 days' prior notice before establishing or acquiring a
new subsidiary, or commencing any new activity through an existing subsidiary.
The Director of the OTS has authority to order termination of subsidiary
activities determined to pose a risk to the safety or soundness of the
institution.  In addition, capital requirements require savings institutions to
deduct the amount of their investments in and extensions of credit to
subsidiaries engaged in activities not permissible to national banks from
capital in determining regulatory capital compliance.  The activities of Home
Service Corporation are permissible for national banks.  See "Regulation --
Regulatory Capital Requirements."

COMPETITION

     The Bank experiences substantial competition both in attracting and
retaining savings deposits and in the making of mortgage and other loans.

     Direct competition for savings deposits comes from other savings
institutions, credit unions, regional bank holding companies and commercial
banks located in its primary market area.  Significant competition for the
Bank's other deposit products and services comes from money market mutual funds,
brokerage firms, insurance companies and retail stores.  The primary factors in
competing for loans are interest rates and loan origination fees and the range
of services offered by various financial institutions.  Competition for
origination of real estate loans normally comes from other savings institutions,
commercial banks, mortgage bankers, mortgage brokers and insurance companies.

     Home Federal's primary competition comprises the commercial banks near each
of the Bank's branch offices.  In Middlesboro, where the Bank's main office is
located, primary competition consists of two banks and one savings bank.  In
Harlan, Kentucky where a branch office is located, the Bank's primary
competition is two banks.  In New Tazewell, Tennessee, where a branch office is
located, the Bank's primary competition is three banks.

     Home Federal is able to compete effectively in its primary market area by
offering competitive interest rates and loan fees, and a wide variety of deposit
products, and by emphasizing personal customer service.  Management believes
that, as a result of the Bank's commitment to competitive pricing, varied
products and personal service, the Bank has developed a solid base of core
deposits and the Bank's loan origination quality and volume are among the
leaders in the Bank's market area.

EMPLOYEES

     As of June 30, 1998, Home Federal and its subsidiary had 52 full-time
employees, none of whom was represented by a collective bargaining agreement.
Home Federal believes that it enjoys excellent relations with its personnel.

                                       24
<PAGE>
 
                                  REGULATION

REGULATION OF THE BANK

     GENERAL.  As a savings association, Home Federal is subject to extensive
regulation by the OTS.  The lending activities and other investments of the Bank
must comply with various federal regulatory requirements.  The OTS will
periodically examine the Bank for compliance with various regulatory
requirements.  The FDIC also has the authority to conduct examinations of SAIF
members.  The Bank must file reports with OTS describing its activities and
financial condition.  The Bank is also subject to certain reserve requirements
promulgated by the Federal Reserve Board.  This supervision and regulation is
intended primarily for the protection of depositors.  Certain of these
regulatory require  ments are referred to below or appear elsewhere herein.

     REGULATORY CAPITAL REQUIREMENTS.  Under OTS regulations, savings
institutions, to be "adequately" capitalized must maintain "tangible" capital
equal to 1.5% of adjusted total assets, "core" capital equal to 4.0% of adjusted
total assets and "total risk-based" capital (a combination of core and
"supplementary" capital) equal to 8.0% of "risk-weighted" assets.  In addition,
OTS regulations impose certain restrictions on savings institutions that have a
total risk-based capital ratio that is less than 8.0%, a ratio of Tier 1 capital
to risk-weighted assets of less than 4.0% or a ratio of Tier 1 capital to
adjusted total assets of less than 4.0% (or 3.0% if the institution is rated
CAMEL 1 under the OTS examination rating system).  For purposes of these
regulations, Tier 1 capital has the same definitions as core capital.  See 
"--Prompt Corrective Regulatory Action." Core capital is defined as common
stockholders' equity (including retained earnings), noncumulative perpetual
preferred stock and related surplus, minority interests in the equity accounts
of fully consolidated subsidiaries, certain nonwithdrawable accounts and pledged
deposits and "qualifying supervisory goodwill." Core capital is generally
reduced by the amount of an institution's intangible assets for which no market
exists. Limited exceptions to the deduction of intangible assets are provided
for purchased mortgage servicing rights, purchased credit card relationships and
qualifying supervisory goodwill held by an eligible institution.

     Tangible capital is given the same definition as core capital but does not
include qualifying supervisory goodwill and is reduced by the amount of all the
savings association's intangible assets with only a limited exception for
purchased mortgage servicing rights and purchased credit card relationships.
Both core and tangible capital are further reduced by an amount equal to savings
association's debt and equity investments in subsidiaries engaged in activities
not permissible to national banks other than subsidiaries engaged in activities
undertaken as agent for customers or in mortgage banking activities and
subsidiary depository institutions or their holding companies.  As of June 30,
1998, the Bank had no investments in or extensions of credit to subsidiaries
engaged in activities not permitted to national banks.

     "Adjusted total assets" are a savings association's total assets as
determined under generally accepted accounting principles, adjusted for certain
goodwill amounts and increased by a prorated portion of the assets of
subsidiaries in which the savings association holds a minority interest and
which are not engaged in activities for which the capital rules require the
savings association to net its debt and equity investments in such subsidiaries
against capital.  Adjusted total assets are reduced by the amount of assets that
have been deducted from capital, the portion of savings association's
investments in subsidiaries that must be deducted from capital under the capital
rules and, for purposes of the core capital requirement, qualifying supervisory
goodwill.

     In determining compliance with the risk-based capital requirement, a
savings association is allowed to use both core capital and supplementary
capital provided the amount of supplementary capital used does not exceed the
savings association's core capital.  Supplementary capital is defined to include
certain preferred stock issues, nonwithdrawable accounts and pledged deposits
that do not qualify as core capital, certain approved subordinated debt, certain
other capital instruments and a portion of the savings association's general
loss allowances. Total core and supplementary capital are reduced by the amount
of capital instruments held by other depository institutions pursuant to
reciprocal arrangements, all equity investments and that portion of the
institution's land loans and non-residential construction loans

                                       25
<PAGE>
 
in excess of 80% loan-to-value ratio. As of June 30, 1998, the Bank had no high
ratio land or non-residential construction loans and no equity investments for
which OTS regulations require a deduction from total capital.

     The risk-based capital requirement is measured against risk-weighted
assets, which equals the sum of each asset and the credit-equivalent amount of
each off-balance sheet item after being multiplied by an assigned risk weight.
Under the OTS risk-weighting system, one- to four-family first mortgages not
more than 90 days past due with loan-to-value ratios under 80% are assigned a
risk weight of 50%.  Consumer and residential construction loans are assigned a
risk weight of 100%.  Mortgage-backed securities issued, or fully guaranteed as
to principal and interest, by the FHLMC are assigned a 20% risk weight.  Cash
and U.S. Government securities backed by the full faith and credit of the U.S.
Government are given a 0% risk weight.

     At June 30, 1998 Home Federal exceeded its tangible, core and risk-based
regulatory capital requirements.  For more information, see "Selected
Consolidated Financial and Other Data -- Regulatory Capital Ratios" in the
Annual Report filed as Exhibit 13 to this report.

     The OTS' risk-based capital requirements require that requires savings
institutions with more than a "normal" level of interest rate risk to maintain
additional total capital.  A savings institution's interest rate risk is
measured in terms of the sensitivity of its "net portfolio value" to changes in
interest rates.  Net portfolio value is defined, generally, as the present value
of expected cash inflows from existing assets and off-balance sheet contracts
less the present value of expected cash outflows from existing liabilities.  A
savings institution is considered to have a "normal" level of interest rate risk
exposure if the decline in its net portfolio value after an immediate 200 basis
point increase or decrease in market interest rates (whichever results in the
greater decline) is less than two percent of the current estimated economic
value of its assets.  A savings institution with a greater than normal interest
rate risk is required to deduct from total capital, for purposes of calculating
its risk-based capital requirement, an amount (the "interest rate risk
component") equal to one-half the difference between the institution's measured
interest rate risk and the normal level of interest rate risk, multiplied by the
economic value of its total assets.

     The OTS calculates the sensitivity of a savings institution's net portfolio
value based on data submitted by the institution in a schedule to its quarterly
Thrift Financial Report and using the interest rate risk measurement model
adopted by the OTS.  The amount of the interest rate risk component, if any, to
be deducted from a savings institution's total capital is based on the
institution's Thrift Financial Report filed two quarters earlier.  Institutions
with less than $300 million in assets and a risk-based capital ratio above 12%
are generally exempt from filing the interest rate risk schedule with their
Thrift Financial Reports.  However, the OTS requires any exempt institution that
it determines may have a high level of interest rate risk exposure to file such
schedule on a quarterly basis and may be subject to an additional capital
requirement based upon its level of interest rate risk as compared to its peers.
The Bank has determined that, on the basis of current financial data, it would
not be deemed to have more than normal level of interest rate risk under the new
rule and believes that it will not be required to increase its total capital as
a result of the rule.

     In addition to requiring generally applicable capital standards for savings
institutions, the Director of the OTS is authorized to establish the minimum
level of capital for a savings institution at such amount or at such ratio of
capital-to-assets as the Director determines to be necessary or appropriate for
such institution in light of the particular circumstances of the institution.
Such circumstances would include a high degree of exposure of interest rate
risk, prepayment risk, credit risk and concentration of credit risk and certain
risks arising from non-traditional activities.  The Director of the OTS may
treat the failure of any institution to maintain capital at or above such level
as an unsafe or unsound practice and may issue a directive requiring any
institution which fails to maintain capital at or above the minimum level
required by the Director to submit and adhere to a plan for increasing capital.
Such an order may be enforced in the same manner as an order issued by the FDIC.

     PROMPT CORRECTIVE REGULATORY ACTION.  FDICIA requires the federal banking
regulators to take prompt corrective action if an institution fails to satisfy
certain minimum capital requirements.  Under FDICIA, capital requirements
include a leverage limit, a risk-based capital requirement, and any other
measure deemed appropriate by

                                       26
<PAGE>
 
the federal banking regulators for measuring the capital adequacy of an insured
depository institution.  All institutions, regardless of their capital levels,
are restricted from making any capital distribution or paying any management
fees that would cause the institution to become undercapitalized.  An
institution that fails to meet the minimum level for any relevant capital
measure (an "undercapitalized institution") generally is: (i) subject to
increased monitoring by the appropriate federal banking regulator; (ii) required
to submit an acceptable capital restoration plan within 45 days; (iii) subject
to asset growth limits; and (iv) required to obtain prior regulatory approval
for acquisitions, branching and new lines of business.  A significantly
undercapitalized institution, as well as any undercapitalized institution that
does not submit an acceptable capital restoration plan, may be subject to
regulatory demands for recapitalization, broader application of restrictions on
transactions with affiliates, limitations on interest rates paid on deposits,
asset growth and other activities and possible replacement of directors and
officers.  The senior executive officers of a significantly undercapitalized
institution may not receive bonuses or increases in compensation without prior
approval and the institution is prohibited from making payments of principal or
interest on its subordinated debt, with certain exceptions.  If an institution's
ratio of tangible capital to total assets falls below a level established by the
appropriate federal banking regulator, which may not be less than 2.0% of total
assets nor more than 65% of the minimum tangible capital level otherwise
required (the "critical capital level"), the institution will be subject to
conservatorship or receivership within 90 days unless periodic determinations
are made that forbearance from such action would better protect the deposit
insurance fund.  Unless appropriate findings and certifications are made by the
appropriate federal bank regulatory agencies, a critically undercapitalized
institution must be placed in receivership if it remains critically
undercapitalized on average during the calendar quarter beginning 270 days after
the date it became critically undercapitalized.

     The OTS measures a savings institution's capital adequacy on the basis of
its total risk-based capital ratio (the ratio of its total capital to risk-
weighted assets), Tier 1 risk-based capital ratio (the ratio of its core capital
to risk-weighted assets) and leverage ratio (the ratio of its core capital to
adjusted total assets).   A savings institution that is not subject to an order
or written directive to meet or maintain a specific capital level will be deemed
"well-capitalized" if it also has: (i) a total risk-based capital ratio of 10%
or greater; (ii) a Tier 1 risk-based capital ratio of 6.0% or greater; and 
(iii) a leverage ratio of 5.0% or greater. An "adequately capitalized" savings
institution is a savings institution that does not meet the definition of well-
capitalized and has: (i) a total risk-based capital ratio of 8.0% or greater;
(ii) a Tier 1 capital risk-based ratio of 4.0% or greater; and (iii) a leverage
ratio of 4.0% or greater (or 3.0% or greater if the savings institution has a
composite 1 CAMELS rating).  An "undercapitalized institution" is a savings
institution that has (i) a total risk-based capital ratio less than 8.0%; or
(ii) a Tier 1 risk-based capital ratio of less than 4.0%; or (iii) a leverage
ratio of less than 4.0% (or 3.0% if the institution has a composite 1 CAMELS
rating).  A "significantly undercapitalized" institution is defined as a savings
institution that has: (i) a total risk-based capital ratio of less than 6.0%; or
(ii) a Tier 1 risk-based capital ratio of less than 3.0%; or (iii) a leverage
ratio of less than 3.0%.  A "critically undercapitalized" savings institution is
defined as a savings institution that has a ratio of core capital to total
assets of less than 2.0%.  The OTS may reclassify a well capitalized savings
institution as adequately capitalized and may require an adequately capitalized
or undercapitalized institution to comply with the supervisory actions
applicable to institutions in the next lower capital category if the OTS
determines, after notice and an opportunity for a hearing, that the savings
institution is in an unsafe or unsound condition or that the institution has
received and not corrected a less-than-satisfactory rating for any CAMELS rating
category.  The Bank is classified as "well-capitalized" under these regulations.

     QUALIFIED THRIFT LENDER TEST.  The Bank is currently subject to OTS
regulations which use the concept of a qualified thrift lender ("QTL") to
determine eligibility for FHLB advances and for certain other purposes.  A
savings institution that does not meet the QTL test must either convert to a
bank charter or comply with the following restrictions on its operations: 
the institution may not engage in any new activity or make any new investment,
(i) directly or indirectly, unless such activity or investment is permissible
for a national bank; (ii) the branching powers of the institution shall be
restricted to those of a national bank; (iii) the institution shall not be
eligible to obtain any advances from its FHLB; and (iv) payment of dividends by
the institution shall be subject to the rules regarding payment of dividends by
a national bank. Upon the expiration of three years from the date the
institution ceases to be a QTL, it must cease any activity and not retain any
investment not permissible for a national bank and immediately repay any
outstanding FHLB advances (subject to safety and soundness considerations).

                                       27
<PAGE>
 
     To qualify as a QTL, a savings institution must either qualify as a
"domestic building and loan association" under the Internal Revenue Code or
maintain at least 65% of its "portfolio" assets in Qualified Thrift Investments.
Portfolio assets are defined as total assets less intangibles, property used by
an institution in its business and liquidity investments in an amount not
exceeding 20% of assets.   All of the following may be included as Qualified
Thrift Investments: investments in residential mortgages, home equity loans,
loans made for educational purposes, small business loans and credit card loans
and shares of stock issued by the FHLB.  Subject to a 20% of portfolio assets
limit, savings institutions are also able to treat the following as Qualified
Thrift Investments: (i) 50% of the dollar amount of residential mortgage loans
subject to sale under certain conditions, (ii) investments, both debt and
equity, in the capital stock or obligations of any other security issued by a
service corporation or operating subsidiary, provided that such subsidiary
derives at least 80% of its annual gross revenues from activities directly
related to purchasing, financing, constructing or improving, repairing domestic
residential housing or manufactured housing, (iii) 200% of their investments in
loans to finance "starter homes" and loans for construction, development or
improvement of housing and community service facilities or for financing small
businesses in "credit-needy" areas, and (iv) loans for personal, family,
household or educational purposes, provided that the dollar amount treated as
Qualified Thrift Investments may not exceed 10% of the savings institution's
portfolio assets.

     A savings institution shall be deemed a QTL as long as its percentage of
Qualified Thrift Investments continues to equal or exceed 65% in at least nine
out of each 12 months.  An institution will cease to be a QTL if its percentage
of Qualified Thrift Investments as measured by monthly averages over the
immediately preceding 12-month period falls below 65% for four or more months.
An institution that fails to maintain QTL status will be permitted to requalify
once, and if it fails the QTL test a second time, it will become immediately
subject to all penalties as if all time limits on such penalties had expired.

     At June 30, 1998, Home Federal had in excess of 87.18% of assets invested
in Qualified Thrift Investments as currently defined, which were substantially
in excess of the percentage required to qualify by the Bank as a QTL.

     DIVIDEND LIMITATIONS.  Under OTS regulations, the Bank may not pay
dividends on its capital stock if its regulatory capital would thereby be
reduced below the amount then required for the liquidation account established
for the benefit of certain depositors of the Bank at the time of its conversion
to stock form.  In addition, savings association subsidiaries of savings and
loan holding companies are required to give the OTS 30 days prior notice of any
proposed declaration of dividends to the holding company.

     Federal regulations impose additional limitations on the payment of
dividends and other capital distributions (including stock repurchases and cash
mergers) by the Bank.  Under these regulations, a savings institution that,
immediately prior to, and on a pro forma basis after giving effect to, a
proposed capital distribution, has total capital (as defined by OTS regulation)
that is equal to or greater than the amount of its fully phased-in capital
requirements (a "Tier 1 Association") is generally permitted without OTS
approval to make capital distributions during a calendar year in an amount equal
to the greater of (i) 75% of net income for the previous four quarters, or 
(ii) up to 100% of its net income to date during the calendar year plus an
amount that would reduce by one-half the amount by which its total capital to
assets ratio exceeded its fully phased-in capital requirement to assets ratio at
the beginning of the calendar year. A savings association with total capital in
excess of current minimum capital requirements, but not in excess of the fully
phased-in requirements (a "Tier 2 Association"), is permitted to make capital
distributions without OTS approval of up to 75% of its net income for the
previous four quarters, less dividends already paid for such period depending on
the savings association's level of risk-based capital. A savings association
that fails to meet current minimum capital requirements (a "Tier 3 Association")
is prohibited from making any capital distributions without the prior approval
of the OTS. Tier 1 Associations that have been notified by the OTS that they are
in need of more than normal supervision will be treated as either a Tier 2 or
Tier 3 Association. At June 30, 1998, the Bank was a Tier 1 Association.

     The Bank is prohibited from making any capital distributions if after
making the distribution, it would be undercapitalized as defined in the OTS'
prompt corrective action regulations.  After consultation with the FDIC, the

                                       28
<PAGE>
 
OTS may permit a savings association to repurchase, redeem, retire or otherwise
acquire shares or ownership interests if the repurchase, redemption, retirement
or other acquisition: (i) is made in connection with the issuance of additional
shares or other obligations of the institution in at least an equivalent amount;
and (ii) will reduce the institution's financial obligations or otherwise
improve the institution's financial condition.

     In addition to the foregoing, earnings of the Bank appropriated to bad debt
reserves and deducted for federal income tax purposes are not available for
payment of cash dividends or other distributions to the Company without payment
of taxes at the then current tax rate by the Bank on the amount of earnings
removed from the reserves for such distributions.  See "Taxation."

     DEPOSIT INSURANCE.  The Bank is required to pay assessments, based on a
percentage of its insured deposits, to the FDIC for insurance of its deposits by
the FDIC through the SAIF.  Under the Federal Deposit Insurance Act, the FDIC is
required to set semi-annual assessments for SAIF-insured institutions at a level
necessary to maintain the designated reserve ratio of the SAIF at 1.25% of
estimated insured deposits, or at a higher percentage of estimated insured
deposits that the FDIC determines to be justified for that year by circumstances
indicating a significant risk of substantial future losses to the SAIF.

     Under the FDIC's risk-based deposit insurance assessment system, the
assessment rate for an insured depository institution depends on the assessment
risk classification assigned to the institution by the FDIC, which is determined
by the institution's capital level and supervisory evaluations.  Based on the
data reported to regulators for the date closest to the last day of the seventh
month preceding the semi-annual assessment period, institutions are assigned to
one of three capital groups -- well capitalized, adequately capitalized or
undercapitalized -- using the same percentage criteria as in the prompt
corrective action regulations.  See "-- Prompt Corrective Regulatory Action."
Within each capital group, institutions are assigned to one of three subgroups
on the basis of supervisory evaluations by the institution's primary supervisory
authority and such other information as the FDIC determines to be relevant to
the institution's financial condition and the risk posed to the deposit
insurance fund.  Subgroup A consists of financially sound institutions with only
a few minor weaknesses.  Subgroup B consists of institutions that demonstrate
weaknesses which, if not corrected, could result in significant deterioration of
the institution and increased risk of loss to the deposit insurance fund.
Subgroup C consists of institutions that pose a substantial probability of loss
to the deposit insurance fund unless effective corrective action is taken.

     Historically, institutions with SAIF-assessable deposits, like the Bank,
were required to pay higher deposit insurance premiums than institutions with
deposits insured by the Bank Insurance Fund ("BIF") also administered by the
FDIC.  In order to recapitalize the SAIF and rectify the premium disparity, the
Deposit Insurance Funds Act of 1996 authorized the FDIC to impose a one-time
special assessment on institutions with SAIF-assessable deposits, based on the
amount determined by the FDIC to be necessary to increase the reserve levels of
the SAIF to the designated reserve ratio of 1.25% of insured deposits.
Institutions were assessed at the rate of 65.7 basis points based on the amount
of their SAIF-assessable deposits as of March 31, 1995.  As a result of the
special assessment the Bank incurred a pre-tax expense of $706,000, during the
fiscal 1997.

     The FDIC then adopted the current assessment schedule for SAIF deposit
insurance pursuant to which the assessment rate for well-capitalized
institutions with the highest supervisory ratings is zero and institutions in
the lowest risk assessment classification are assessed at the rate of 0.31% of
insured deposits.  Until December 31, 1999, however, SAIF-insured institutions,
will be required to pay assessments to the FDIC at the rate of 6.5 basis points
to help fund interest payments on certain bonds issued by the Financing
Corporation ("FICO"), an agency of the federal government established to finance
takeovers of insolvent thrifts.  During this period, BIF members will be
assessed for these obligations at the rate of 1.3 basis points.  After December
31, 1999, both BIF and SAIF members will be assessed at the same rate for FICO
payments.  Since the SAIF now meets its designated reserve ratio, SAIF members
are permitted to convert to the status of members of the BIF and may merge with
or transfer assets to a BIF member.  However, substantial entrance and exit fees
apply to conversions from SAIF to BIF insurance and such fees may make a SAIF to
BIF conversion prohibitively expensive.

                                       29
<PAGE>
 
     The FDIC has adopted a regulation which provides that any insured
depository institution with a ratio of Tier 1 capital to total assets of less
than 2% will be deemed to be operating in an unsafe or unsound condition, which
would constitute grounds for the initiation of termination of deposit insurance
proceedings.  The FDIC, however, would not initiate termination of insurance
proceedings if the depository institution has entered into and is in compliance
with a written agreement with its primary regulator, and the FDIC is a party to
the agreement, to increase its Tier 1 capital to such level as the FDIC deems
appropriate.  Tier 1 capital is defined as the sum of common stockholders'
equity, noncumulative perpetual preferred stock (including any related surplus)
and minority interests in consolidated subsidiaries, minus all intangible assets
other than mortgage servicing rights and qualifying supervisory goodwill
eligible for inclusion in core capital under OTS regulations and minus
identified losses and investments in certain securities subsidiaries.  Insured
depository institutions with Tier 1 capital equal to or greater than 2% of total
assets may also be deemed to be operating in an unsafe or unsound condition
notwithstanding such capital level.  The regulation further provides that in
considering applications that must be submitted to it by savings institutions,
the FDIC will take into account whether the institution is meeting the Tier 1
capital requirement for state non-member banks of 4% of total assets for all but
the most highly rated state non-member banks.

     TRANSACTIONS WITH AFFILIATES.  Transactions between savings associations
and any affiliate are governed by Sections 23A and 23B of the Federal Reserve
Act.  An affiliate of a savings association is any company or entity which
controls, is controlled by or is under common control with the savings
association.  In a holding company context, the parent holding company of a
savings association (such as the Company) and any companies which are controlled
by such parent holding company are affiliates of the savings association.
Generally, Sections 23A and 23B (i) limit the extent to which the savings
institution or its subsidiaries may engage in "covered transactions" with any
one affiliate to an amount equal to 10% of such institution's capital stock and
surplus, and contain an aggregate limit on all such transactions with all
affiliates to an amount equal to 20% of such capital stock and surplus, and 
(ii) require that all such transactions be on terms substantially the same, or
at least as favorable, to the institution or subsidiary as those provided to a
nonaffiliate. The term "covered transaction" includes the making of loans,
purchase of assets, issuance of a guarantee and similar other types of
transactions. In addition to the restrictions imposed by Sections 23A and 23B,
no savings association may (i) loan or otherwise extend credit to an affiliate,
except for any affiliate which engages only in activities which are permissible
for bank holding companies, or (ii) purchase or invest in any stocks, bonds,
debentures, notes or similar obligations of any affiliate, except for affiliates
which are subsidiaries of the savings association. Section 106 of the Bank
Holding Company Act of 1956, as amended ("BHCA") which also applies to the Bank,
prohibits the Bank from extending credit to or offering any other services, or
fixing or varying the consideration for such extension of credit or service, on
the condition that the customer obtain some additional service from the
institution or certain of its affiliates or not obtain services of a competitor
of the institution, subject to certain exceptions.

     Further, savings institutions are subject to the restrictions contained in
Section 22(h) and Section 22(g) of the Federal Reserve Act and the Federal
Reserve Board's Regulation O thereunder on loans to executive officers,
directors and principal stockholders.  Under Section 22(h), loans to a director,
executive officer and to a greater than 10% stockholder of a savings institution
and certain affiliated interests of such persons, may not exceed, together with
all other outstanding loans to such person and affiliated interests, the
institution's loans-to-one-borrower limit (generally equal to 15% of the
institution's unimpaired capital and surplus and an additional 10% of such
capital and surplus for loans fully secured by certain readily marketable
collateral).  Section 22(h) also prohibits the making of loans above amounts
prescribed by the appropriate federal banking agency, to directors, executive
officers and greater than 10% stockholders of a savings institution, and their
respective affiliates, unless such loan is approved in advance by a majority of
the board of directors of the institution with any "interested" director not
participating in the voting.  Regulation O prescribes the loan amount (which
includes all other outstanding loans to such person) as to which such prior
board of director approval is required as being the greater of $25,000 or 5% of
capital and surplus (up to $500,000).  Further, Section 22(h) requires that
loans to directors, executive officers and principal stockholders be made on
terms substantially the same as offered in comparable transactions to other
persons.  Section 22(h) also generally prohibits a depository institution from
paying the overdrafts of any of its executive officers or directors.

                                       30
<PAGE>
 
     Section 22(g) of the Federal Reserve Act and Regulation O requires that
loans to executive officers of a depository institution requires that loans  not
be made on terms more favorable than those afforded to other borrowers, requires
approval for such extensions of credit by the board of directors of the
institution, and imposes reporting requirements for and additional restrictions
on the type, amount and terms of credits to such officers.   In addition,
Section 106 of the BHCA prohibits extensions of credit to executive officers,
directors, and greater than 10% stockholders of a depository institution by any
other institution which has a correspondent banking relationship with the
institution, unless such extension of credit is on substantially the same terms
as those prevailing at the time for comparable transactions with other persons
and does not involve more than the normal risk of repayment or present other
unfavorable features.

     LIQUIDITY REQUIREMENTS.  The Bank is required to maintain average daily
balances of liquid assets (cash, deposits maintained pursuant to Federal Reserve
Board requirements, time and savings deposits in certain institutions,
obligations of the United States and states and political subdivisions thereof,
shares in mutual funds with certain restricted investment policies, highly rated
corporate debt and mortgage loans and mortgage-related securities with less that
one year to maturity or subject to pre-arranged sale within one year) equal to
the monthly average of not less than a percentage (currently 4%) of its net
withdrawable savings deposits plus short-term borrowings.  Monetary penalties
may be imposed for failure to meet liquidity requirements.  The average daily
liquidity ratio of the Bank for the month of June 1998 was 26.2.%.

     FEDERAL HOME LOAN BANK SYSTEM.  The Bank is a member of the FHLB System,
which consists of twelve district Federal Home Loan Banks subject to supervision
and regulation by the Federal Housing Finance Board ("FHFB").  The Federal Home
Loan Banks provide a central credit facility primarily for member institutions.
As a member of the FHLB of Cincinnati, the Bank is required to acquire and hold
shares of capital stock in the FHLB of Cincinnati in an amount at least equal to
1% of the aggregate unpaid principal of its home mortgage loans, home purchase
contracts, and similar obligations at the beginning of each year, or 1/20 of 
its advances (borrowings) from the FHLB of Cincinnati, whichever is greater.
As of June 30, 1998, the Bank had an investment in FHLB Cincinnati stock of 
$1.3 million.

     The FHLB of Cincinnati serves as a reserve or central bank for its member
institutions within its assigned district.  It is funded primarily from proceeds
derived from the sale of consolidated obligations of the FHLB System.  It makes
advances to members in accordance with policies and procedures established by
the FHFB and the Board of Directors of the FHLB of Cincinnati.  Long-term
advances may only be made for the purpose of providing funds for residential
housing finance.  See "Deposit Activities and Other Sources of Funds --
Borrowings."

     FEDERAL RESERVE SYSTEM.  Pursuant to regulations of the Federal Reserve
Board, a thrift institution must maintain average daily reserves equal to
various percentages of its accounts in a manner sufficient to satisfy its
reserve requirements on reservable liabilities.  No reserves are required to be
maintained on the first $4.3 million of transaction accounts, reserves equal to
3% must be maintained on the next $49.3 million of transaction accounts, and a
reserve of 10% must be maintained against all remaining transaction accounts.
These reserve requirements are subject to adjust  ment by the Federal Reserve
Board.  Because required reserves must be maintained in the form of vault cash
or in a non-interest bearing account at a Federal Reserve Bank, the effect of
the reserve requirement is to reduce the amount of the institution's interest-
earning assets.  As of June 30, 1998, the Bank met its reserve requirements.

     SAFETY AND SOUNDNESS GUIDELINES.  Under FDICIA, as amended by the Riegle
Community Development and Regulatory Improvement Act of 1994 (the "CDRI Act"),
each Federal banking agency is required to establish safety and soundness
standards for institutions under its authority.  On July 10, 1995, the Federal
banking agencies, including the OTS, released Interagency Guidelines
Establishing Standards for Safety and Soundness and published a final rule
establishing deadlines for submission and review of safety and soundness
compliance plans.  The final rule and the guidelines went into effect on August
9, 1995.  The guidelines require savings institutions to maintain internal
controls and information systems and internal audit systems that are appropriate
for the size, nature and scope of the institution's business.  The guidelines
also establish certain basic standards for loan documentation, credit
underwriting, interest rate

                                       31
<PAGE>
 
risk exposure, and asset growth.  The guidelines further provide that savings
institutions should maintain safeguards to prevent the payment of compensation,
fees and benefits that are excessive or that could lead to material financial
loss, and should take into account factors such as comparable compensation
practices at comparable institutions.  If the OTS determines that a savings
institution is not in compliance with the safety and soundness guidelines, it
may require the institution to submit an acceptable plan to achieve compliance
with the guidelines.  A savings institution must submit an acceptable compliance
plan to the OTS within 30 days of receipt of a request for such a plan.  Failure
to submit or implement a compliance plan may subject the institution to
regulatory sanctions.  Management believes that the Bank meets substantially all
the standards adopted in the interagency guidelines.

     Additionally under FDICIA, as amended by the CDRI Act, the federal banking
agencies are required to establish standards relating to the asset quality and
earnings that the agencies determine to be appropriate.  On July 10, 1995, the
federal banking agencies, including the OTS, issued proposed guidelines relating
to asset quality and earnings.  Under the proposed guidelines a savings
institution should maintain systems, commensurate with its size and the nature
and scope of its operations, to identify problem assets and prevent
deterioration in those assets as well as to evaluate and monitor earnings and
ensure that earnings are sufficient to maintain adequate capital and reserves.
Management believes that the asset quality and earnings standards, in the form
proposed by the banking agencies, would not have a material effect on the Bank's
operations.

REGULATION OF THE COMPANY

     GENERAL.  The Company is a unitary savings and loan holding company within
the meaning of the HOLA.  As such, the Company is registered with the OTS and
subject to OTS regulations, examinations, supervision and reporting
requirements.  The Company also is required to file certain reports with, and
otherwise comply with the rules and regulations of, the Securities and Exchange
Commission ("SEC") under the federal securities laws.

     ACTIVITIES RESTRICTIONS.  The Board of Directors of the Company presently
intends to operate the Company as a unitary savings and loan holding company.
There are generally no restrictions on the activities of a unitary savings and
loan holding company.  However, if the Director of OTS determines that there is
reasonable cause to believe that the continuation by a savings and loan holding
company of an activity constitutes a serious risk to the financial safety,
soundness, or stability of its subsidiary savings association, the Director of
OTS may impose such restrictions as deemed necessary to address such risk and
limiting (i) payment of dividends by the savings association, (ii) transactions
between the savings association and its affiliates, and (iii) any activities of
the savings association that might create a serious risk that the liabilities of
the holding company and its affiliates may be imposed on the savings
association.  Notwithstanding the above rules as to permissible business
activities of unitary savings and loan holding companies, if the savings
association subsidiary of such a holding company fails to meet the QTL Test,
then such unitary holding company shall also be subject to the activities
restrictions applicable to multiple holding companies and unless the savings
association requalifies as a Qualified Thrift Lender within one year thereafter,
register as, and become subject to, the restrictions applicable to a bank
holding company.

     If the Company were to acquire control of another savings association,
other than through merger or other business combination with the Bank, the
Company would thereupon become a multiple savings and loan holding company.
Except where such acquisition is pursuant to the authority to approve emergency
thrift acquisitions and where each subsidiary savings association meets the QTL
Test, the activities of the Company and any of its subsidiaries (other than the
Bank or other subsidiary savings institutions) would thereafter be subject to
further restrictions.  The Home Owners' Loan Act provides that, among other
things, no multiple savings and loan holding company or subsidiary thereof which
is not a savings association shall commence or continue for a limited period of
time after becoming a multiple savings and loan holding company or subsidiary
thereof, any business activity, upon prior notice to, and no objection by the
OTS, other than (i) furnishing or performing management services for a
subsidiary savings association, (ii) conducting an insurance agency or escrow
business, (iii) holding, managing, or liquidating assets owned by or acquired
from a subsidiary savings institution, (iv) holding or managing properties used
or occupied by a subsidiary savings institution, (v) acting as trustee under
deeds of trust, (vi) those activities authorized by regulation as of

                                       32
<PAGE>
 
March 5, 1987 to be engaged in by multiple holding companies, or (vii) those
activities authorized by the Federal Reserve Board as permissible for bank
holding companies, unless the Director of OTS by regulation prohibits or limits
such activities for savings and loan holding companies.  A multiple savings and
loan holding company must obtain the approval of the OTS prior to engaging in
the activities described in (vii) above.

     RESTRICTIONS ON ACQUISITIONS.  Savings and loan holding companies are
prohibited from acquiring, without prior approval of the Director of OTS, 
(i) control of any other savings association or savings and loan holding company
or substantially all the assets thereof, or (ii) more than 5% of the voting
shares of a savings association or holding company thereof which is not a
subsidiary. Under certain circumstances, a registered savings and loan holding
company is permitted to acquire, with the approval of the Director of OTS, up to
15% of the voting shares of an under-capitalized savings association pursuant to
a "qualified stock issuance" without that savings association being deemed
controlled by the holding company. In order for the shares acquired to
constitute a "qualified stock issuance," the shares must consist of previously
unissued stock or treasury shares, the shares must be acquired for cash, the
savings and loan holding company's other subsidiaries must have tangible capital
of at least 6-1/2% of total assets, there must not be more than one common
director or officer between the savings and loan holding company and the issuing
savings association and transactions between the savings association and the
savings and loan holding company and any of its affiliates must conform to
Sections 23A and 23B of the Federal Reserve Act. Except with the prior approval
of the Director of OTS, no director or officer of a savings and loan holding
company or person owning or controlling by proxy or otherwise more than 25% of
such company's stock, may also acquire control of any savings association, other
than a subsidiary savings association, or of any other savings and loan holding
company.

     The Director of OTS may only approve acquisitions resulting in the
formation of a multiple savings and loan holding company which controls savings
associations in more than one state if:  (i) the multiple savings and loan
holding company involved controls a savings institution which operated a home or
branch office in the state of the association to be acquired as of March 5,
1987; (ii) the acquiror is authorized to acquire control of the savings
association pursuant to the emergency acquisition provisions of the Federal
Deposit Insurance Act; or (iii) the statutes of the state in which the
association to be acquired is located specifically permit institutions to be
acquired by state-chartered associations or savings and loan holding companies
located in the state where the acquiring entity is located (or by a holding
company that controls such state-chartered savings institutions).

     OTS regulations permit federal savings associations to branch in any state
or states of the United States and its territories.  Except in supervisory cases
or when interstate branching is otherwise permitted by state law or other
statutory provision, a federal savings association may not establish an out-of-
state branch unless (i) the federal association qualifies as a QTL or as a
"domestic building and loan association" under (S)7701(a)(19) of the Internal
Revenue Code and the total assets attributable to all branches of the
association in the state would qualify such branches taken as a whole for
treatment as a QTL or as a domestic building and loan association and (ii) such
branch would not result in (a) formation of a prohibited multi-state multiple
savings and loan holding company, or (b) a violation of certain statutory
restrictions on branching by savings association subsidiaries of banking holding
companies.  Federal savings associations generally may not establish new
branches unless the association meets or exceeds minimum regulatory capital
requirements.  The OTS will also consider the association's record of compliance
with the Community Reinvestment Act of 1977 in connection with any branch
application.

     Under the BHCA, bank holding companies are specifically authorized to
acquire control of any savings institution.  Pursuant to rules promulgated by
the Federal Reserve Board, owning, controlling or operating an institution is a
permissible activity for bank holding companies, if the savings institution
engages only in deposit-taking activities and lending and other activities that
are permissible for bank holding companies.  A bank holding company that
controls a savings institution may merge or consolidate the assets and
liabilities of the savings institution with, or transfer assets and liabilities
to, any subsidiary bank which is a member of the BIF with the approval of the
appropriate federal banking agency and the Federal Reserve Board.  The resulting
bank will be required to continue to pay assessments to the SAIF at the rates
prescribed for SAIF members on the deposits attributable to the merged savings
institution plus an annual

                                       33
<PAGE>
 
growth increment.  In addition, the transaction must comply with the
restrictions on interstate acquisitions of commercial banks under the BHCA.


                                    TAXATION

     GENERAL.  The Company and its subsidiaries file a consolidated federal
income tax return on a June 30 fiscal year basis.  Consolidated returns have the
effect of eliminating intercompany distributions, including dividends, from the
computation of consolidated taxable income for the taxable year in which the
distributions occur.

     FEDERAL AND STATE INCOME TAXATION.  Savings institutions are subject to the
provisions of the Internal Revenue Code of 1986, as amended (the "Code") in the
same general manner as other corporations.  Prior to recent legislation,
institutions such as the Bank which met certain definitional tests and other
conditions prescribed by the Code benefitted from certain favorable provisions
regarding their deductions from taxable income for annual additions to their bad
debt reserve.  For purposes of the bad debt reserve deduction, loans are
separated into "qualifying real property loans," which generally are loans
secured by interests in certain real property, and nonqualifying loans, which
are all other loans.  The bad debt reserve deduction with respect to
nonqualifying loans must be based on actual loss experience.  The amount of the
bad debt reserve deduction with respect to qualifying real property loans may be
based upon actual loss experience (the "experience method") or a percentage of
taxable income determined without regard to such deduction (the "percentage of
taxable income method").  Legislation recently signed by the President repealed
the percentage of taxable income method of calculating the bad debt reserve.
The Bank has generally elected to use the method which has resulted in the
greatest deductions for federal income tax purposes.

     Legislation that is effective for tax years beginning after December 31,
1995 requires institutions to recapture into taxable income over a six taxable
year period the portion of the tax loan loss reserve that exceeds the pre-1988
tax loan loss reserve.  The Bank will no longer be allowed to use the percentage
of taxable income method for tax loan loss provisions, but would be allowed to
use the experience method of accounting for bad debts.  There will be no future
effect on net income of the Bank from the recapture because the taxes on these
bad debts reserves have been accrued as a deferred tax liability.  Beginning
with the first taxable year beginning after December 31, 1995, savings
institutions, such as the Bank, will be treated the same as commercial banks.
Institutions with $500 million or more in assets will only be able to take a tax
deduction when a loan is actually charged off.  Institutions with less than 
$500 million in assets will still be permitted to make deductible bad debt
additions to reserves, but only using the experience method.

     The legislation provides for a suspension of this recapture if the
institution meets the "residential loan requirement."  This requirement is met
if the principal amount of residential loans that the institution originates
during its first taxable year after December 31, 1995, exceeds the average of
the principal amounts of residential loans made by the institution during the
six most recent taxable years beginning before January 1, 1996.  If the
requirement is met, the recapture is suspended until a taxable year beginning
December 31, 1997, or until the residential loan requirement is not met in a
subsequent year.  The Bank met this requirement for the taxable year ended 
June 30, 1998.  

     Under the experience method, the bad debt deduction for an addition to the
reserve for qualifying real property loans is an amount determined under a
formula based generally on the bad debts actually sustained by a savings
institution over a period of years.   Under the percentage of taxable income
method, the bad debt reserve deduction for qualifying real property loans is
computed as a percentage, which Congress has reduced from as much as 60% in
prior years to 8% of taxable income, with certain adjustments, effective for
taxable years beginning after 1986.  The allowable deduction under the
percentage of taxable income method (the "percentage bad debt deduction") for
taxable years beginning before 1987 was scaled downward in the event that less
than 82% of the total dollar amount of the assets of an institution were within
certain designated categories.  When the percentage method bad debt deduction
was lowered to 8%, the 82% qualifying assets requirement was lowered to 60%.
For all taxable years, there is no deduction in the event that less than 60% of
the total dollar amount of the assets of an institution falls within such
categories.  Moreover,

                                       34
<PAGE>
 
in such case, the Bank could be required to recapture, generally over a period
of up to four years, its existing bad debt reserve.

     Earnings appropriated to the Bank's bad debt reserve and claimed as a tax
deduction are not available for the payment of cash dividends or for
distribution to stockholders (including distributions made on dissolution or
liquidation), unless the Bank includes the amount in taxable income, along with
the amount deemed necessary to pay the resulting federal income tax.

     The Bank's federal income tax return for the period ended June 30, 1993,
was audited by the Internal Revenue Service in 1995.  The examination did not
significantly effect the Bank's tax liability.  For further information
regarding federal income taxes see "Income Tax" included in the Notes to
Consolidated Financial Statements.

     The Commonwealth of Kentucky imposes no income or franchise taxes on
savings institutions.  However, the Company (on an unconsolidated basis) and the
Bank's wholly-owned subsidiary must pay a Kentucky state income tax, as well as
a tax on capital.  The tax on income is 4.0% for the first $25,000 of taxable
income, 5.0% for the next $25,000, 6.0% for the next $50,000, 7.0% for the next
$150,000 and 8.25% for all income over $250,000.  The tax on capital is .0021
times the capital employed.

     The Bank is subject to a Kentucky ad valorem tax.  Assessed at the
beginning of each calendar year, this tax is 0.1% of the Bank's savings
accounts, common stock, capital, and retained income with certain deductions for
amounts borrowed by depositors and for securities guaranteed by the U.S.
Government or certain of its agencies.  For the fiscal year ended June 30, 1998,
the amount of such expense was approximately $123,000 and is included in
noninterest expense in the Consolidated Statements of Earnings.

     In addition to the Bank's federal income tax liability, the State of
Tennessee imposes an excise tax on savings institutions at the rate of 6% of net
taxable income, which is computed based on federal taxable income allocable to
Tennessee, subject to certain adjustments.  The State of Tennessee also imposes
franchise and privilege taxes on savings institutions based on assets, which, in
the case of the Bank, have not constituted significant expense items.

ACCOUNTING PRONOUNCEMENTS

     The financial Accounting Standards Board ("FASB") has issued Statement 
No. 130, Reporting Comprehensive Income, which establishes standards for
reporting and display of comprehensive income and its components in a full set
of general-purpose financial statements, Statement No. 131, Disclosures About
Segments of an Enterprise and Related Information, which establishes standards
for disclosing information about operating segments in interim and annual
financial statements. Statement No. 132, Employers' Disclosures About Pensions
and other Postretirement Benefits, which revises employers disclosures about
pension and other postretirement benefit plans, and Statement NO. 133,
Accounting for Derivative Instruments and Hedging Activities, which requires
companies to record derivatives on the balance sheet at their face value.
Statements Nos. 130, 131 and 132 will be effective for the Company beginning in
fiscal 1999 and will not have any material impact on the Company's financial
condition or results of operations. Statement No. 133 will be effective for the
Company beginning in fiscal 2000 and is also not expected to have a material
impact on the Company's financial condition or results of operations.

                                       35
<PAGE>
 
ITEM 2.  PROPERTIES
-------------------

     The following table sets forth the location and certain additional
information regarding the Bank's offices at June 30, 1998.   The Bank owns its
main office and New Tazewell Branch, and leases its Harlan Branch.

<TABLE>
<CAPTION>
                                     Year    Square
                                    Opened   Footage    Net Book Value
                                    ------   -------    --------------
     <S>                             <C>     <C>        <C>
     MAIN OFFICE:
     1602 Cumberland Avenue (1)
     Middlesboro, Kentucky           1980     9,500      $1,027,414
 
     BRANCH OFFICES:
     Village Center (2)              1975     3,300         244,965
     Harlan, Kentucky
 
     600 Fifth Avenue (1)
     New Tazewell, Tennessee         1995     5,000         754,683
 
      Total                                              $2,027,062
                                                         ==========
-------------------------
</TABLE>
(1)  Owned by Home Service Corporation, the Bank's wholly-owned subsidiary, and
     leased to the Bank.
(2)  In November 1990, the lease on this property was renegotiated for a seven-
     year term with three five-year options.  The annual rent is $39,803.  The
     Bank is liable to reimburse the lessor for its proportionate share of any
     increase in real estate taxes and insurance paid by lessor.  The rent
     expense for years 1998 and 1997 was $39,803 and $39,803, respectively.


     DHI Computing, Inc. Provo, Utah, performs data processing and record
keeping for Home Federal.  The Bank's fixtures and equipment include a network
of teller terminals, several computers, Frame Relay communications equipment,
ATMs and a check processing machine.

     At June 30, 1998, the net book value of the Bank's premises, furniture,
fixtures, equipment and land for future development was $2.2 million.  It is
Management's opinion that all of the Bank's properties are adequately covered by
insurance.  See "Premises and Equipment" included in the Notes to Consolidated
Financial Statements in the Annual Report.

ITEM 3. LEGAL PROCEEDINGS.
------------------------- 

     From time to time, the Bank is a party to various routine legal proceedings
incident to its business, including loan foreclosure actions.  There are
currently no material legal proceedings to which the Company, the Bank or its
subsidiary is a party or to which any of their property is subject.

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

     No matters were submitted to a vote of security holders during the fourth
quarter of the fiscal year ended June 30, 1998.

                                    PART II

ITEM 5.  MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
--------------------------------------------------------------------------
MATTERS
-------

     The information contained under the section captioned "Market Information"
in the Bank's Annual Report to Stockholders for the Fiscal Year Ended June 30,
1998 (the "Annual Report") is incorporated herein by reference.  For
information regarding restrictions on the payment of dividends see Item 1.
"Business -- Regulation -- Regulation of the Bank -- Dividend Limitations."

                                       36
<PAGE>
 
ITEM 6.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
--------------------------------------------------------------------------------
OF OPERATIONS
-------------

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

ITEM 7.  FINANCIAL STATEMENTS
-----------------------------

     The Consolidated Financial Statements and Related Notes contained in the
Annual Report are incorporated herein by reference.

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

     Not applicable.


                                    PART III

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

     For information regarding delinquent filers and the disclosure required
pursuant to Item 405 of Regulation S-KSB, reference is made to the section
captioned "Section 16(a) Beneficial Ownership Reporting Compliance" in the Proxy
Statement which information is incorporated herein by reference.

ITEM 10.  EXECUTIVE COMPENSATION
--------------------------------

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

ITEM 11.  SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
------------------------------------------------------------------------

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

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

ITEM 12.  CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
--------------------------------------------------------

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

                                       37
<PAGE>
 
ITEM 13.  EXHIBITS, LISTS AND REPORTS ON FORM 8-K.
------------------------------------------------- 

     (A)  LIST OF DOCUMENTS FILED AS PART OF THIS REPORT
          ----------------------------------------------

              The following exhibits are either attached to or incorporated by
        reference in this Annual Report on Form 10-KSB.

              Description
              -----------

        3.1   Articles of Incorporation of HFB Financial Corporation * 

        3.2   Bylaws of HFB Financial Corporation *

        4     Common Stock Certificate of HFB Financial Corporation *

       10.1   HFB Financial Corporation Stock Option Plan *

       10.2   Home Federal Bank, Federal Savings Bank Management *
              Recognition Plan

       10.3   Home Federal Bank, Federal Savings Bank Supplemental *
              Executive Retirement Plan

       10.4   Employment Agreement between the Bank and David B. Cook *

       10.5   Employment Agreement between the Bank and Stanley Alexander, Jr. *

       13     Annual Report to Stockholders for the Fiscal Year Ended June 30,
              1998

       21     Subsidiaries of the Registrant

       27     Financial Data Schedule

--------------------
*    Incorporated by reference to the Corporation's Registration Statement on
     Form S-1 (33-52308) filed with the Securities and Exchange Commission on
     September 23, 1992.


     (B)  REPORTS ON FORM 8-K.   None.
     ------------------------         

                                       38
<PAGE>
 
                                   SIGNATURES

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

     HFB FINANCIAL CORPORATION


October 9, 1998                      By: /s/ David B. Cook                    
                                         --------------------------------------
                                         David B. Cook                        
                                         President and Chief Executive Officer 

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


/s/ David B. Cook                               October 9, 1998
----------------------------                     
David B. Cook
President and Chief Executive Officer
and Director
(Principal Executive Officer)


/s/ Stanley Alexander, Jr.                      October 9, 1998
----------------------------                                   
Stanley Alexander, Jr.
Chief Financial Officer
(Principal Financial and Accounting Officer)


/s/ E. W. Nagle                                 October 9, 1998
----------------------------                                      
E. W. Nagle
Director


/s/ Frank W. Lee                                October 9, 1998
----------------------------                                       
Frank W. Lee
Secretary-Treasurer and Director


/s/ Frances Coffey Rasnic                       October 9, 1998
----------------------------                                 
Frances Coffey Rasnic                       
Director                                    
                                            
                                            
/s/ Charles Harris                              October 9, 1998
----------------------------                                     
Charles Harris
Director


/s/ Earl Burchfield                             October 9, 1998
----------------------------                                    
Earl Burchfield 
Director


/s/ Robert V. Costanzo                          October 9, 1998
----------------------------                                 
Robert V. Costanzo
Director

                                       39
<PAGE>
 
                               INDEX TO EXHIBITS



Exhibit No.     Description
-----------     -----------
               
     3.1        Articles of Incorporation of HFB Financial Corporation * 
               
     3.2        Bylaws of HFB Financial *
               
     4          Common Stock Certificate of HFB Financial Corporation * 
               
    10.1        HFB Financial Corporation Stock Option Plan *
               
    10.2        Home Federal Bank, Federal Savings Bank Management
                Recognition Plan *
               
    10.3        Home Federal Bank, Federal Savings Bank Supplemental
                Executive Retirement Plan *
               
    10.4        Employment Agreement between the Bank and David B. Cook *  
               
    10.5        Employment Agreement between the Bank and Stanley
                Alexander, Jr. *
               
    13          Annual Report to Stockholders for the Fiscal Year Ended         
                June 30, 1998

    21          Subsidiaries of the Registrant

    27          Financial Data Schedule

-------------------------
*    Incorporated by reference to the Corporation's Registration Statement on
     Form S-1 (33-52308) filed with the Securities and Exchange Commission on
     September 23, 1992.