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                       SECURITIES AND EXCHANGE COMMISSION
                             Washington, D.C. 20549

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


                                   FORM 10-KSB

     (Mark One)

[X]  ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
       SECURITIES EXCHANGE ACT OF 1934
     For the fiscal year ended September 30, 1998

[ ]  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
       SECURITIES EXCHANGE ACT OF 1934
     For the transition period from                        to
                                    ----------------------     ----------------

                         Commission File Number: 1-13640

                           SOUTHFIRST BANCSHARES, INC.
             (Exact name of registrant as specified in its charter)

                             A Delaware Corporation
                  I.R.S. Employer Identification No. 63-1121255

                              126 North Norton Ave.
                            Sylacauga, Alabama 35150
                                 (205) 245-4365

                 Securities Registered Pursuant to Section 12(b)
                              of the Exchange Act:

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

                 Securities Registered Pursuant to Section 12(g)
                            of the Exchange Act: None

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

         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 the 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]

         Issuer's Revenues for the fiscal year ended September 30, 1998:
$13,088,065

         The aggregate market value of the common equity held by nonaffiliates
of the Registrant (674,210 shares), computed using the closing price as reported
on the American Stock Exchange for the Registrant's Common Stock on December 24,
1998, was $10,955,912. For the purposes of this response, officers, directors
and holders of 5% or more of the Registrant's Common Stock are considered the
affiliates of the Registrant.

         The number of shares outstanding of the Registrant's Common Stock as of
December 24, 1998: 999,244 shares of $.01 par value common stock.

                       DOCUMENTS INCORPORATED BY REFERENCE

         The information required by Part III of Form 10-KSB is, pursuant to
General Instruction E(3) of Form 10-KSB, incorporated by reference from the
Company's definitive proxy statement (the "Proxy Statement") to be filed
pursuant to Regulation 14A with the Commission not later than 120 days after the
end of the fiscal year covered by this form.

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


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SAFE HARBOR STATEMENT UNDER THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995

         Management has endeavored in its communications, in its Annual Report,
and in this Form 10-KSB to highlight the trends and factors that might have an
impact on SouthFirst Bancshares, Inc. ("SouthFirst") and the industry in which
SouthFirst competes. Any "forward-looking statements" within the meaning of the
Private Securities Litigation Reform Act of 1995, which statements generally can
be identified by the use of forward-looking terminology, such as "may," "will,"
"expect," "estimate," "anticipate," "believe," "target," "plan," "project," or
"continue" or the negatives thereof or other variations thereon or similar
terminology, are made on the basis of management's plans and current analyses of
SouthFirst, its business and the industry as a whole. These forward-looking
statements are subject to risks and uncertainties, including, but not limited
to, economic conditions, competition, interest rate sensitivity and exposure to
regulatory and legislative changes. The above factors, in some cases, have
affected, and in the future could affect, SouthFirst's financial performance and
could cause actual results for fiscal 1999 and beyond to differ materially from
those expressed or implied in such forward-looking statements. SouthFirst does
not undertake to publicly update or revise its forward-looking statements even
if experience or future changes make it clear that any projected results
expressed or implied therein will not be realized.

                                     PART I

ITEM 1.  BUSINESS

BUSINESS OF SOUTHFIRST

         SouthFirst Bancshares, Inc. ("SouthFirst") was formed in April of 1994,
at the direction of the Board of Directors of First Federal of the South ("First
Federal"), a federally chartered savings association subject to the regulatory
oversight of the Office of Thrift Supervision ("OTS") for the purpose of
becoming a holding company to own all of the outstanding common stock of First
Federal. On February 13, 1995, First Federal was converted from a mutual to a
stock form of ownership (the "Conversion"), whereupon SouthFirst, approved by
the OTS as a thrift holding company, acquired all of the issued and outstanding
shares of First Federal. SouthFirst's business primarily involves directing,
planning and coordinating the business activities of First Federal. In the
future, SouthFirst may acquire or organize other operating affiliates or
subsidiaries, including other financial institutions.

         To date, SouthFirst has neither owned nor leased any property, but has
instead used the premises, equipment and furniture of First Federal. At the
present time, because SouthFirst does not intend to employ any persons other
than officers, it will continue utilizing the support staff of First Federal
from time to time. Additional employees may be hired as appropriate to the
extent SouthFirst expands in the future.

BUSINESS OF FIRST FEDERAL

         GENERAL

         First Federal was organized in 1949 as a federally chartered mutual
savings and loan association under the name Sylacauga Federal Savings and Loan
Association. In 1959, First Federal changed its name to First Federal Savings
and Loan Association of Sylacauga. In the Conversion, First Federal changed its
name to First Federal of the South. First Federal is a member of the Federal
Home Loan Bank (the "FHLB") System and its deposit accounts are insured up to
the maximum amount allowable by the FDIC.

         At September 30, 1998, First Federal conducted business from four
full-service locations in Alabama. These locations included its main office in
Sylacauga and branches in Talladega, Clanton, and Centreville. In addition,
First Federal operates loan production offices in the Alabama cities



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of Hoover, Dothan and Rainbow City, the latter two of which were opened in April
of 1998, primarily to enhance First Federal's construction lending activities in
the fast growing "wire grass" region in the state as well as the strong
construction market in northwest Florida. The loan production office in Rainbow
City focuses primarily on real estate mortgage loans. Because of its close
proximity to Gadsden, Alabama, First Federal's loan production office in Rainbow
City is also able to serve the Gadsden market area, which is an area
experiencing significant increases in home construction. First Federal will also
pursue other types of loans such as consumer, commercial, and real estate
mortgage loans in the Dothan, Rainbow City and Gadsden market areas as demands
dictate.

         On April 27, 1998 SouthFirst submitted an application with the Office
of Thrift Supervision, seeking approval to exercise limited trust powers and to
create an operating subsidiary to exercise limited trust powers. This proposed
subsidiary would provide limited trust services to the SouthFirst's wholly-
owned subsidiary, Pension & Benefit Financial Services, Inc. ("Pension &
Benefit"). As of September 30, 1998 this application had been deemed
substantially approved by the OTS, and SouthFirst was awaiting final approval.
See "PROPERTIES."

         First Federal's principal business has been, and continues to be,
attracting retail deposits from the general public and investing those deposits,
together with funds generated from operations, primarily in one-to-four family
mortgage loans, constructions loans, mortgage-backed securities, collateralized
mortgage obligations ("CMOs") and investment securities.

         First Federal's revenues are derived principally from interest and fees
on loans in its portfolio and from mortgage-backed securities, CMOs, investment
securities portfolios and customer service fees. First Federal's primary sources
of funds are deposits and proceeds from principal and interest payments on
loans, mortgage-backed securities, CMOs, FHLB advances and other investment
securities. First Federal's primary expense is interest paid on deposits.

         First Federal markets its one-to-four family residential loans and
deposit accounts primarily to persons in Talladega, Chilton, and Bibb Counties
in Alabama. Mortgage loans are generated from depositors, walk-in customers,
referrals from local real estate brokers and developers and, to a limited
extent, local radio and newspaper advertising. Construction loan originations
are attributable largely to First Federal's lending officers' reputations and
their long-standing relationships with builders and developers in the market
areas they serve. See "-- Construction Lending."

         First Federal offers its customers fixed rate and adjustable rate
mortgage loans, residential construction loans, as well as other consumer loans,
including savings account loans. Fixed rate mortgage loans with maturities of 15
years or less are originated for retention in First Federal's loan portfolio
while other fixed rate mortgage loans are generally sold upon origination to the
secondary market. One-year adjustable rate loans with 30-year maturities are
generally originated for retention in First Federal's loan portfolio. All
consumer loans are retained in First Federal's portfolio.

         To attract deposits, First Federal offers a selection of deposit
accounts including NOW, money market, passbook savings and certificates of
deposit. First Federal offers competitive rates and relies substantially on
customer service, advertising and long-standing relationships with customers to
attract and retain deposits.

         MARKET AREA

         First Federal's primary deposit gathering and lending area covers
Talladega, Chilton and Bibb Counties in central Alabama. To a lesser extent,
First Federal's deposit gathering and lending area covers the adjoining Alabama
counties of Coosa, Shelby, Clay, Cleburne, Calhoun, St. Clair and Jefferson.
Talladega County has a population of approximately 77,000 based on 1996 census
data as published by the U.S. Bureau of Vital Statistics. Chilton County and
Bibb County had populations of approximately



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35,000 and 18,000, respectively, based on 1996 CACI, Inc. estimates. First
Federal's main office in Sylacauga is situated approximately 38 miles southeast
of Birmingham, the largest city in Alabama. First Federal's branch office in
Talladega is situated approximately 55 miles east of Birmingham. First Federal's
Clanton office is located approximately 55 miles north of Montgomery. First
Federal's Centreville office is located approximately 25 miles south of
Tuscaloosa. First Federal's loan production office in Hoover is situated within
the Birmingham metropolitan area. The Dothan loan production office is located
approximately 191 miles southeast of Birmingham. The Rainbow City loan
production is approximately 15 miles south of Gadsden and 62 miles northeast of
Birmingham.

         First Federal is the largest financial institution headquartered in
Sylacauga and is the second largest in Talladega County. Talladega County has a
diversified economy based primarily on textile and other manufacturing,
wholesale, retail, mining, service, government, agriculture and tourism.
Manufacturing accounts for approximately one-third of total employment in
Talladega County. The economy is generally stable and there has been no
substantial increase or decrease in the population in the last five years.

         Sylacauga's economy is based primarily on major industrial employers
such as ECC International, Inc., Sullivan Graphics, Inc., Avondale Mills,
Russell Corporation, Blue Bell Ice Cream, Pursell Industries and Georgia Marble.
U.S. Alliance Corporation, a paper manufacturer, is a major employer in
Childersburg, Alabama, located 10 miles from Sylacauga in Talladega County.

         Talladega's economy is based largely on major textile manufacturing
employers such as Brecon Knitting Mills, Wehadkee Yarn Mills, and Image
Industries, Inc. Georgia-Pacific Corporation also employs a number of persons in
Talladega. In addition, Talladega is the home of the Talladega Superspeedway
which hosts the Winston 500 and other NASCAR events and attracts individuals to
Talladega County primarily from the southeast region of the United States.

         First Federal's Clanton office, in Chilton County, and Centreville
office, in Bibb County, were each acquired by First Federal on October 31, 1997.
Although Chilton and Bibb Counties are generally rural areas in which the
economy is largely based on the growth and harvesting of peaches, each of these
counties has been experiencing relatively higher growth rates than Talladega
County in terms of population and households. Chilton County's employers include
GulfStates Paper Corp., International Paper Corp. and Union Camp Corp. Both
counties are in close proximity to the Birmingham metropolitan area. Bibb County
is located near Tuscaloosa and the fast-growing town of Vance, the home of a new
Mercedes-Benz manufacturing plant.

         RESIDENTIAL LENDING

         First Federal's primary lending activity consists of the origination of
one-to-four family, owner-occupied, residential mortgage loans secured by
property located in First Federal's market area. Originations for such loans are
generally obtained from existing or past customers, realtors, referrals,
walk-ins, and, to a lesser extent, local newspaper and radio advertising. Loans
are originated by First Federal personnel. No loan brokers or commissioned loan
officers are used. Conventional residential loans are priced based on rates
offered by the local competition and the secondary market. At September 30,
1998, First Federal had $77.4 million, 74% of its loan portfolio, invested in
one-to-four family residential mortgage loans. Management believes that this
policy of focusing on one-to-four family lending has been effective in
contributing to net interest income while reducing credit risk by keeping loan
delinquencies and losses to a minimum.

         First Federal offers conventional fixed rate one-to-four family
mortgage loans with terms of 15 and 30 years. Fixed rate loans are generally
underwritten either according to Federal Home Loan Mortgage Corporation
("FHLMC") or Federal National Mortgage Association ("FNMA") guidelines,
utilizing their approved documents so that the loans qualify for sale in the
secondary mortgage market. 



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Generally, First Federal holds a portion of its fixed rate mortgage loans with
maturities not exceeding 15 years in its portfolio as long-term investments.

         Adjustable rate mortgage ("ARM") loans originated by First Federal
consist of one-, three-, five-, and seven-year ARMs that are indexed to the
comparable maturity Treasury index or various cost of funds indexes. At
September 30, 1998, First Federal held approximately $34.4 million ARMs, which
represented approximately 32.9% of First Federal's total loan portfolio. First
Federal's ARM loans are subject to a limitation of 2.0% per adjustment for
interest rate increases and decreases. In addition, ARM loans currently
originated by First Federal typically have a lifetime cap of 6.0% on increases
in the interest rate. These limits, based on the initial rate, may reduce the
interest rate sensitivity of such loans during periods of changing interest
rates. The repayment terms of ARM loans may increase the likelihood of
delinquencies during periods of rising interest rates. First Federal offers
teaser rates on ARM loans to remain competitive. Adjustable-rate loans which
provide for teaser rates may be subject to increased risk of delinquency or
default as the higher, fully indexed rate of interest subsequently replaces the
lower, initial rate.

         Regulations limit the amount which a savings association may lend in
relationship to the appraised value of the real estate securing the loan, as
determined by an appraisal at the time of loan origination. Such regulations
permit a maximum loan-to-value ratio of 100% for residential property and 90%
for all other real estate loans. First Federal's lending policies, however,
generally limit the maximum loan-to-value ratio to 95% of the appraised value of
the property, based on an independent appraisal. For Federal Housing
Administration ("FHA"), Veterans' Administration ("VA") and Farmers' Home Loans,
First Federal generally limits the maximum loan-to-value ratio to 100% of the
appraised value of the property. When First Federal makes a loan in excess of
80% of the appraised value or purchase price, private mortgage insurance is
required.

         The loan-to-value ratio, maturity and other provisions of the
residential real estate loans made by First Federal reflect the policy of making
loans generally below the maximum limits permitted under applicable regulations.
For all residential mortgage loans originated by First Federal, upon receipt of
a completed loan application from a prospective borrower, a credit report is
ordered, income, employment and certain other information are verified; and, if
necessary, additional financial information is requested. First Federal requires
an independent appraisal, title insurance (or an attorney's opinion), flood
hazard insurance (if applicable), and fire and casualty insurance on all
properties securing real estate loans made by First Federal. First Federal
reserves the right to approve the selection of which title insurance companies'
policies are acceptable to insure the real estate in the loan transactions.

         Members of the First Federal Board of Directors receive a monthly
summary of all loans which are closed. Construction loans in excess of $350,000
and all other loans in excess of $250,000 require authorizations by the Loan
Committee of the First Federal Board prior to closing. First Federal issues
written, formal commitments as to interest rates to prospective borrowers upon
request on real estate loans at the date of application. The interest rate
commitment remains valid for 45 to 60 days (the "lock-in period") from the date
of the application. Upon receipt of loan approval, the borrower has the balance
of the lock-in period to close the loan at the interest rate committed.

         Originated mortgage loans held in First Federal's portfolio generally
include due-on-sale clauses which provide First Federal with the contractual
right to deem the loan immediately due and payable in the event that the
borrower transfers ownership of the property without First Federal's consent. It
is First Federal's policy to enforce due-on-sale provisions or to require that
the interest rate be adjusted to the current market rate when ownership is
transferred.

         First Federal also offers loans secured by second mortgages on real
estate, such as home improvement and home equity loans. On September 30, 1998,
such loans amounted to $3,840,000. Second mortgage loans are extended for up to
80% of the appraised value of the property, less existing


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liens, at an adjustable or fixed interest rate. Home equity loans are extended
in amounts up to 100% of the appraised value of the property, with the
requirement that private mortgage insurance be obtained. First Federal generally
holds the first mortgage loans on the properties securing the second mortgages.

         CONSTRUCTION LENDING

         At September 30, 1998, committed construction loans secured by
single-family residential property totaled $20.8 million; of this amount,
approximately $6.1 million was not disbursed. First Federal makes construction
loans primarily to builders for the construction of single-family residences, on
both a pre-sold and speculative basis. First Federal also makes construction
loans on single-family residences to individuals who will ultimately be the
owner-occupant of the house.

         Construction loan proceeds are disbursed in increments as construction
progresses. Disbursements are scheduled by contract, with First Federal
reviewing the progress of the underlying construction project prior to each
disbursement. First Federal's construction loan agreements with builders
generally provide that principal repayments are required as individual units are
sold to third parties.

         Construction loans are principally made to builders who have an
established credit history with First Federal, as well as to builders who are
referred by such borrowers. New builders must be approved by First Federal's
Loan Committee and must display the same levels of knowledgeability and
financial strength as existing builders. The application process includes a
submission to First Federal of plans, specifications and costs of the project to
be constructed or developed. The Loan Committee also reviews the borrower's
existing financial condition and total debt outstanding. All borrower
relationships are reviewed annually by the Loan Committee. First Federal's
residential construction loans are originated with adjustable or fixed rates of
interest that are negotiated with the builders, but typically will be tied to
the prime rate plus a spread and have terms of 12 months or less. Construction
loans generally have a maximum loan-to-value ratio of 80% on an "as completed"
basis. First Federal generally obtains personal guarantees for all of its
construction loans. First Federal converts many of its construction loans to
permanent loans upon completion of the construction phase.

         Construction loans generally involve a higher level of credit risk than
permanent single-family residential lending, due to the concentration of
principal in a limited number of borrowers and the effects of changing economic,
governmental and weather conditions. The nature of these loans is such that they
require a sophisticated knowledge of building standards, material costs, union
rules, real estate values and housing demand; and, thus, are more difficult to
evaluate and monitor. First Federal's risk of loss on a construction loan is
dependent largely upon the accuracy of the initial estimate of the property's
value upon completion of the project and the estimated cost (including interest)
of the project. If the estimate of construction cost proves to be inaccurate,
First Federal may be required to advance funds beyond the amount originally
committed in order to permit completion of the project and will be confronted,
at or prior to the maturity of the loan, with a project having a value which is
insufficient to assure full repayment.

         Jimmy C. Maples, First Vice President of First Federal, manages the
Hoover loan production office. His primary responsibility is to manage the
construction lending portfolio of First Federal. Mr. Maples performs all
underwriting of the construction loans and has the authority to originate
construction loans out of the Hoover office up to $350,000. No other loan
officer of First Federal has such authority. Loans in excess of $350,000 must be
approved by the Loan Committee of the First Federal Board of Directors. Funds
are disbursed based upon percentage of completion as verified by on-site
inspections performed by Mr. Maples.

         Mr. Maples is responsible for soliciting business, performing credit
risk assessments and annual credit reviews, preparing loan origination
documents, maintaining loan files, performing site inspections and disbursing
loan proceeds. Also, as previously discussed, Mr. Maples has the authority to
originate 




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construction loans out of the Hoover office in amounts up to $350,000. First
Federal is heavily dependent on Mr. Maples for determining the quality of the
construction loan portfolio and the accuracy of the recorded balances. Mr.
Maples reports loan information to the First Federal Board on a monthly basis.
In addition, First Federal has instituted a system of internal procedures to
help ensure that construction loan interest, construction loan balances and
other related construction loan accounts are fairly stated. Over time, these
procedures have been developed and closely coordinated with First Federal's
independent auditors and First Federal's Internal Control Review Committee which
reports to the First Federal Board of Directors on a quarterly basis.

         At September 30, 1998, 13 borrowers had construction loan commitments
in excess of $500,000 with the largest commitment being $2,079,000. The majority
of loans in the construction loan portfolio were made on a speculative basis. As
previously discussed, construction loans are typically outstanding for a period
of 12 months or less. If the loan is not paid within the original 12 month
period, it is renewed for a six month period. All renewals are approved by First
Federal's Loan Committee. As of September 30, 1998, there were 22 such renewal
loans totaling $3,363,674.

         Under federal law, the aggregate amount of loans that First Federal is
permitted to make to any one borrower is generally limited to the greater of 15%
(25% if the security has a readily ascertainable value) of unimpaired capital
and surplus or $500,000. First Federal has received permission from the OTS to
increase its loan to one borrower limits for single-family residential builders,
as permitted under applicable federal law and regulations. The increased limit
for these borrowers is 30% of unimpaired capital and surplus of First Federal,
with an aggregate limit to all such borrowers equal to 150% of First Federal's
unimpaired capital and surplus.

         COMMERCIAL LENDING

         At September 30, 1998, commercial lending accounted for only 0.33%, or
$348,000, of First Federal's total loan portfolio. First Federal's commercial
loans are secured by real estate or other acceptable collateral. In addition,
borrowers generally must personally guarantee loans secured by commercial real
estate. Commercial loans are mostly made at adjustable rates.

         Commercial loans generally involve a greater degree of risk than
residential mortgage loans. Because payments on loans are often dependent on
successful operation or management of business, repayment of such loans may be
subject to a greater extent to adverse economic conditions. First Federal seeks
to minimize these risks by lending to established customers and generally
restricting such loans to its primary market area. Due to the growth in
commercial lending in recent years, First Federal has increased its commercial
loan portfolio.

         CONSUMER LENDING AND OTHER LENDING

         As a community-oriented financial institution, First Federal offers
certain consumer loans, including both unsecured loans and loans secured by
assets such as deposits, vehicles, and heavy equipment. At September 30, 1998,
consumer loans totaled $12.3 million, or 11.8% of First Federal's total loan
portfolio. This amount includes $2.0 million of loans secured by savings
accounts, $2.7 million of loans secured by vehicles, and $7.6 million in other
secured loans.

         The underwriting standards employed by First Federal for consumer loans
include a determination of the applicant's payment history on other debts and an
assessment of ability to meet existing obligations and payments on the proposed
loan. In addition, the stability of the applicant's monthly income from primary
employment is considered during the underwriting process. Creditworthiness of
the applicant is of primary consideration; however, the underwriting process
also includes a comparison of the value of the security, if any, in relation to
the proposed loan amount.



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         LOAN APPROVAL

         All first-mortgage loans, other than construction loans less than
$350,000, are underwritten and approved by the Loan Committee of the First
Federal Board of Directors. One-to-four family loans in excess of $250,000 and
construction loans in excess of $350,000 must be approved by the Loan Committee.
Mr. Maples has sole underwriting and loan approval authority for any
construction loans up to $350,000. See "-- Construction Lending." First Federal
has implemented a second loan review policy applicable to all loans that are
brought before the Loan Committee that the Loan Committee has not yet approved
or denied. The second loan review for loans that have not yet been approved or
denied is performed by designated members of First Federal's Internal Control
Review Committee on a timely basis following the initial meeting of the Loan
Committee. After the second loan review, the Loan Committee makes a final
determination as to whether the loan application will be denied or approved.

         LOAN ORIGINATION, COMMITMENT AND OTHER FEES AND COMMISSIONS

         In addition to interest earned on loans, First Federal charges fees for
originating and making loan commitments, prepayments of non-residential loans,
late payments, changes in property ownership and other miscellaneous services.
The income realized from such fees varies with the volume of loans made or
repaid, and the fees vary from time to time depending upon the supply of funds
and other competitive conditions in the mortgage markets. Loan demand and the
availability of money also affect these conditions. Fees, net of related
origination costs, are deferred as an adjustment to yield. First Federal also
charges commissions on the sale of credit life insurance and fees in connection
with retail banking activities which are reflected in First Federal's
non-interest operations income.

         COMPETITION

         First Federal has significant competition for its residential real
estate mortgage loans, construction loans and other loans and deposits in
Talladega, Jefferson, Chilton and Bibb Counties. The cities of Sylacauga,
Talladega and Clanton have a high density of financial institutions, some of
which are larger, have a state-wide or regional presence and have greater
financial resources than First Federal, and all of which are competitors of
First Federal to varying degrees. First Federal faces significant competition
both in originating mortgage loans and other loans and in attracting deposits.
First Federal's competition for loans comes principally from savings and loan
associations and commercial banks. In addition, there are a number of mortgage
bankers, mortgage brokers, finance companies and insurance companies that
compete with First Federal for loan customers. Credit unions, securities firms
and mutual funds compete with First Federal in raising deposits. Many of these
institutions also seek to provide the same community-oriented services as First
Federal. First Federal competes for deposit accounts by offering depositors
competitive interest rates and a high level of personal service. First Federal
competes for loans primarily through the interest rates and loan fees it charges
and the efficiency and quality of service it provides borrowers and contractors.
Competition in the financial services industry has increased significantly
within the past several years as a result of federal and state legislation which
has, in several respects, deregulated financial institutions. The full impact of
this legislation and subsequent laws cannot be fully assessed or predicted.

         First Federal's loan production offices also face significant
competition for originations of residential construction loans. First Federal's
competition for these loans comes principally from larger savings institutions
and commercial banks who have greater financial resources than First Federal.
First Federal competes for residential construction loans primarily through the
quality of service it provides borrowers and the long-standing business
relationships that First Federal has with builders and developers in the area.

         First Federal is a community and retail-oriented financial institution
serving its market area with deposit services, residential and commercial real
estate loans and consumer loans. Management considers 



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First Federal's reputation for financial strength and quality customer service
to be its major competitive advantage in attracting and retaining customers in
its market area. While First Federal is subject to competition from other
financial institutions which may have greater financial and marketing resources,
management believes First Federal benefits from its community orientation and
its long-standing relationship with many of its customers.

         DATA PROCESSING

         First Federal has entered into a data processing servicing agreement
with Kirchman Corp. This servicing agreement provides for First Federal to
receive a full range of data processing services, including an automated general
ledger, deposit accounting, commercial, real estate and installment lending data
processing, central information file and ATM processing and investment portfolio
accounting.

         EMPLOYEES

         First Federal presently employs 66 individuals on a full-time basis,
including 18 officers, and 7 individuals on a part-time basis. First Federal
will hire additional persons as needed, including additional tellers and
financial service representatives.

         YEAR 2000

         In the next two years, many companies may face a potentially serious
information systems problem because their computer software applications and
operational programs may not properly recognize calendar dates beginning in the
year 2000. This problem could force computers to either shut down or provide
incorrect data or information. First Federal began the process of identifying
the changes required to its computer programs and hardware in early 1997.
Software upgrades designed to correct the year 2000 problem were completed
during the early part of calendar year 1998. Presently, First Federal is in the
process of testing all of its operating systems in order to be ready for year
2000. As of September 30, 1998, First Federal does not anticipate the cost of
any future software and hardware changes (if necessary) to have a material
adverse impact on its business, financial condition, or results of operation.
However, there can be no assurance that unforeseen difficulties or costs will
not arise. First Federal has issued certification requests to the data
processing and software companies on which its computer programs rely and to all
major vendors and customers seeking assurance that they will be year 2000
compliant. Approximately 50% of the questionnaires have been returned. All of
the respondents have indicated that they are year 2000 compliant now or will be
well in advance of the year 2000.

         First Federal also recognizes the importance of determining that its
borrowers are facing the Year 2000 problem in a timely manner to avoid
deterioration of its loan portfolio solely due to this issue. All material
relations have been identified to assess the inherent risks. First Federal plans
to work on a one-on-one basis with any borrower who has been identified as
having high Year 2000 risk exposure.

         First Federal's contingency plans relative to Year 2000 issues have not
been finalized. Management will develop and modify a "worse case scenario"
contingency plan which will, among other things, anticipate that the First
Federal's deposit customers will have increased demands for cash in the latter
part of 1999.

FEE-FOR-SERVICE SUBSIDIARIES

         At September 30, 1998, SouthFirst owned a 50% interest in Magnolia
Title Services, Inc. ("Magnolia"), a company which provides title insurance and
related services to borrowers and lenders. Magnolia has not been profitable
since its inception. Start-up losses at Magnolia have resulted in write-downs of
SouthFirst's investment of $245,000 to $144,617. As a consequence, SouthFirst
has undertaken programs to re-evaluate its investment in Magnolia. The results
of these re-evaluations may lead



                                       8
<PAGE>   10

SouthFirst to make certain strategic changes, including further write-downs of
its investment, if certain performance-based goals are not met or as
circumstances may otherwise require.

         In the first quarter of fiscal 1998, SouthFirst terminated its
relationship in the Meta Company ("Meta"), a financial planning and services
business. Start-up losses at Meta have resulted in write-downs of SouthFirst's
initial investment of $175,000 to $96,663 at the time of its dissolution.

SUPERVISION AND REGULATION

GENERAL

         First Federal is chartered as a federal savings institution under the
Home Owners' Loan Act, as amended ("HOLA"), which is implemented by regulations
adopted and administered by the OTS. As a federal savings institution, First
Federal is subject to regulation, supervision and regular examination by the
OTS. Federal banking laws and regulations control, among other things, First
Federal's required reserves, investments, loans, mergers and consolidations,
payment of dividends and other aspects of First Federal's operations. The
deposits of First Federal are insured by the Savings Association Insurance Fund
(the "SAIF"), which is administered by the FDIC, to the maximum extent provided
by law ($100,000 for each depositor). In addition, the FDIC has certain
regulatory and examination authority over OTS-regulated savings institutions and
may recommend enforcement actions against savings institutions to the OTS.

         SouthFirst, as a savings and loan holding company, is also required to
file certain reports with, and otherwise comply with the rules and regulations
of the OTS and of the Securities and Exchange Commission (the "Commission")
under the federal securities laws. Certain of the regulatory requirements
applicable to First Federal and to SouthFirst are referred to below or elsewhere
herein.

         As a federally insured depository institution, First Federal is subject
to various regulations promulgated by the Federal Reserve Board, including
Regulation B (Equal Credit Opportunity), Regulation D (Reserve Requirements),
Regulation E (Electronic Fund Transfers), Regulation Z (Truth in Lending),
Regulation CC (Availability of Funds and Collection of Checks) and Regulation DD
(Truth in Savings).

         The system of regulation and supervision applicable to First Federal
and SouthFirst establishes a comprehensive framework for the operations of First
Federal and SouthFirst, and is intended primarily for the protection of the FDIC
and the depositors of First Federal. Changes in the regulatory framework could
have a material adverse effect on First Federal and its operations that, in
turn, could have a material adverse effect on SouthFirst. To the extent that the
following information describes certain statutory and regulatory provisions, it
is qualified in its entirety by reference to the particular statutory and
regulatory provisions. Any change in applicable laws or regulations may have a
material effect on the business and prospects of SouthFirst.

PROPOSED LEGISLATION

         The United States Congress recently considered legislation that would
have required all federal savings institutions (such as First Federal) to
convert to a national bank or a state bank or savings bank charter. In addition,
the proposed legislation would cause SouthFirst to be regulated not as a savings
and loan holding company, but rather as a bank holding company or "financial
services" holding company (a new regulatory classification created by the
legislation). Although this legislation was not enacted, if similar legislation
were to be adopted in the future, it would eliminate certain advantages now
enjoyed by federal savings institutions, such as unrestricted interstate
branching and the absence of restrictions on the business activities of unitary
savings and loan holding companies. SouthFirst cannot predict whether similar
legislation may be enacted in the future.



                                       9
<PAGE>   11

REGULATION OF SOUTHFIRST

         GENERAL

         As the owner of all of the stock of First Federal, SouthFirst is a
unitary savings and loan holding company subject to regulatory oversight by the
OTS and the Commission. As such, SouthFirst is required to register and file
reports with the OTS and the Commission and is subject to regulation and
examination by the OTS. In addition, the OTS' enforcement authority over
SouthFirst and its non-savings association subsidiaries permits the OTS to
restrict or prohibit activities that are determined to be a serious risk to the
subsidiary savings association. This regulation and oversight is intended
primarily for the protection of the depositors of First Federal rather than for
the benefit of shareholders of SouthFirst.

         QUALIFIED THRIFT LENDER TEST

         As a savings and loan holding company owning only one savings
institution, SouthFirst generally is allowed to engage and invest in a broad
range of business activities not permitted to commercial bank holding companies
or multiple savings and loans holding companies, provided that First Federal
continues to qualify as a "qualified thrift lender." See "-- Regulation of First
Federal and Chilton County -- Qualified Thrift Lender Test." In the event
SouthFirst acquires control of another savings association as a separate
subsidiary, it would become a multiple savings and loan holding company, and the
activities of SouthFirst and any of its subsidiaries (other than First Federal
or any other SAIF-insured savings association) would become subject to
restrictions applicable to bank holding companies unless such other associations
each also qualify as a Qualified Thrift Lender and were acquired in a
supervisory acquisition.

         RESTRICTIONS ON ACQUISITIONS

         SouthFirst must obtain approval from the OTS before acquiring control
of any other SAIF-insured association or savings and loan holding company.
Federal law generally provides that no "person," acting directly or indirectly
or through or in concert with one or more other persons, may acquire "control,"
as that term is defined in OTS regulations, of a federally insured savings
institution without giving at least 60 days' written notice to the OTS and
providing the OTS an opportunity to disapprove the proposed acquisition. Such
acquisition of control may be disapproved if it is determined, among other
things, that (i) the acquisition would substantially lessen competition; (ii)
the financial condition of the acquiring person might jeopardize the financial
stability of the savings institution or prejudice the interests of its
depositors; or (iii) the competency, experience or integrity of the acquiring
person or the proposed management personnel indicates that it would not be in
the interest of the depositors or the public to permit the acquisition of
control by such person. Control of a savings institution or a savings and loan
holding company is conclusively presumed to exist if, among other things, a
person or group of persons acting in concert, directly or indirectly, acquires
more than 25.0% of any class of voting stock of the institution or holding
company or controls in any manner the election of a majority of the directors of
the insured institution or the holding company. Control is rebuttably presumed
to exist if, among other things, a person acquires 10.0% or more of any class of
voting stock (or 25.0% of any class of stock) and is subject to any of certain
specified "control factors."

         The Financial Institutions Reform, Recovery and Enforcement Act of 1989
("FIRREA") amended provisions of the Bank Holding Company Act of 1956 (the
"BHCA") to specifically authorize the Federal Reserve Board to approve an
application by a bank holding company to acquire control of a savings
association. FIRREA also authorized a bank holding company that controls a
savings association to merge or consolidate the assets and liabilities of the
savings association 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 Federal Deposit Insurance
Corporation Improvement Act ("FDICIA") further amended the BHCA to permit
federal savings associations to acquire or be acquired by any insured depository
institution. As a result of these provisions, there have been a number of



                                       10
<PAGE>   12

acquisitions of savings associations by bank holding companies and other
financial institutions in recent years.

         FEDERAL SECURITIES LAWS

         Common stock held by persons who are affiliates (generally officers,
directors and principal shareholders) of SouthFirst may not be resold without
registration or unless sold in accordance with certain resale restrictions. If
SouthFirst meets specified current public information requirements, however,
each affiliate of SouthFirst is able to sell in the public market, without
registration, a limited number of shares in any three-month period.

REGULATION OF FIRST FEDERAL

         INSURANCE OF DEPOSIT ACCOUNTS

         First Federal's deposit accounts are insured by the SAIF to a maximum
of $100,000 for each insured member (as defined by law and regulation). Insured
institutions are members of either the SAIF or the BIF. Pursuant to FIRREA, an
insured institution may not convert from one insurance fund to the other without
the advance approval of the FDIC.

         Under FIRREA, the FDIC is given the authority, should it initiate
proceedings to terminate an institution's deposit insurance, to suspend the
insurance of any such institution without tangible capital. However, if a
savings association has positive capital when it includes qualifying intangible
assets, the FDIC cannot suspend deposit insurance unless capital declines
materially, the institution fails to enter into and remain in compliance with an
approved capital plan, or the institution is operating in an unsafe or unsound
manner.

         Regardless of an institution's capital level, insurance of deposits may
be terminated by the FDIC upon a finding that the institution has engaged in
unsafe or unsound practices, is in an unsafe or unsound condition to continue
operations or has violated any applicable law, regulation, rule, order or
condition imposed by the FDIC or the institution's primary regulator. The
management of First Federal is unaware of any practice, condition or violation
that might lead to termination of its deposit insurance.

         As an insurer, the FDIC issues regulations, conducts examinations and
generally supervises the operations of its insured members. FDICIA directed the
FDIC to establish a risk-based premium system under which the FDIC is directed
to charge an annual assessment for the insurance of deposits based on the risk a
particular institution poses to its deposit insurance fund. Under the FDIC's
risk-related insurance regulations, an institution is classified according to
capital and supervisory factors. Institutions are assigned to one of three
capital groups: "well capitalized," "adequately capitalized" or
"undercapitalized." Within each capital group, institutions are assigned to one
of three supervisory subgroups. There are nine combinations of groups and
subgroups (or assessment risk classifications) to which varying assessment rates
are applicable.

         As a result of the recapitalization of the SAIF implemented by the
Economic Growth and Regulatory Paperwork Reduction Act (the "Economic Growth
Act") (see " -- Special FDIC Assessment"), the FDIC reduced the insurance
assessment rate for SAIF-assessable deposits for periods beginning on October 1,
1996. For the first half of 1997, the FDIC set the effective insurance
assessment rates for SAIF-insured institutions, such as First Federal, at zero
to 27 basis points. In addition, SAIF-insured institutions will be required,
until December 31, 1999, to pay assessments to the FDIC at an annual rate of
between 6.0 and 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 recapitalize the predecessor to the SAIF. During this
period, BIF member banks will be assessed for payment of the 



                                       11
<PAGE>   13

FICO obligations at one-fifth the annual rate applicable to SAIF member
institutions. After December 31, 1999, BIF and SAIF members will be assessed at
the same rate for FICO obligations.

         The Economic Growth Act also provides that the FDIC may not assess
regular insurance assessments for the SAIF unless required to maintain or to
achieve the designated reserve ratio of 1.25%, except for such assessments on
those institutions that are not classified as "well-capitalized" or that have
been found to have "moderately severe" or "unsatisfactory" financial,
operational or compliance weaknesses. First Federal is classified as
"well-capitalized" and has not been found by the OTS to have such supervisory
weaknesses.

         OTS SUPERVISORY ASSESSMENTS

         In addition to federal deposit insurance premiums, savings institutions
like First Federal are required by OTS regulations to pay assessments to the OTS
to fund the operations of the OTS. The general assessment is paid on either a
semi-annual or quarterly basis, as determined by the OTS on an annual basis, and
is computed based on total assets of the institution, including subsidiaries.

         SPECIAL FDIC ASSESSMENT

         On September 30, 1996, the Economic Growth Act was signed into law
pursuant to which the, FDIC imposed a one-time assessment on the deposits of all
depository institutions the accounts of which are insured by the SAIF. The
purpose of the assessment was to recapitalize the SAIF and resolve the current
premium disparity between the SAIF and Bank Insurance Fund ("BIF"). The special
assessment required a payment from each insured depository institution in an
amount equal to .657% of the SAIF-assessable deposits held by it on June 30,
1995. The special assessment was due, and the SAIF became fully capitalized, as
of October 1, 1996. As a SAIF insured institution, First Federal was required to
pay approximately $430,000 in connection with this special assessment.

         REGULATORY CAPITAL REQUIREMENTS

         General. The OTS has adopted capital regulations which establish
capital standards applicable to all savings institutions, including a core
capital requirement, a tangible capital requirement and a risk-based capital
requirement. The OTS also has established pursuant to FDICIA five
classifications for institutions based upon the capital requirements: well
capitalized, adequately capitalized, undercapitalized, significantly
undercapitalized and critically under capitalized. At September 30, 1998, First
Federal was "well capitalized." Failure to maintain that status could result in
greater regulatory oversight or restrictions on First Federal's activities.

         Core Capital and Tangible Capital. The OTS requires savings
institutions receiving a composite examination rating of "1," the best possible
rating under the CAMELS examination rating system, are required to maintain a
ratio of core capital to adjusted total assets of 4.0%. All other savings
associations are required to maintain minimum core capital of at least 4.0% of
total adjusted assets. "Core capital" includes, generally, (i) common
shareholders' equity (including retained earnings), (ii) noncumulative perpetual
preferred stock and related surplus, (iii) nonwithdrawable accounts and certain
pledged deposits of mutual savings associations, and (iv) minority interests in
fully-consolidated subsidiaries, less a savings institution's (A) investments in
certain "non-includable" subsidiaries (as determined by regulation) and (B)
intangible assets (with limited exceptions for purchased mortgage servicing
rights, purchased credit card relationships and certain intangible assets
arising from prior regulatory accounting practices). At September 30, 1998,
First Federal's ratio of tangible and core capital to total adjusted assets was
7.7%.

         The "tangible capital" requirement requires a savings institution to
maintain tangible capital in an amount not less than 1.5% of its adjusted total
assets. "Tangible capital" means (i) common shareholders' equity (including
retained earnings), (ii) noncumulative perpetual preferred stock and related
earnings, (iii) 



                                       12
<PAGE>   14

nonwithdrawable accounts and pledged deposits that qualify as core capital and
(iv) minority interests in equity accounts of fully-consolidated subsidiaries,
less any intangible assets (except for purchased mortgage servicing rights and
purchased credit card relationships included in core capital).

         Risk-Based Capital. The risk-based capital standard for savings
institutions requires the maintenance of total regulatory capital (which is
defined as core capital plus supplementary capital) of 8.0% of risk-weighted
assets. The components of supplementary capital include, among other items,
cumulative perpetual preferred stock, perpetual subordinated debt, mandatory
convertible subordinated debt, intermediate-term preferred stock and the general
allowance for credit losses. The portion of the allowance for credit losses
includable in supplementary capital is limited to a maximum of 1.25% of
risk-weighted assets. Overall, supplementary capital is limited to 100.0% of
core capital. In determining total risk-weighted assets for purposes of the
risk-based capital requirements, (i) each off-balance sheet item must be
converted to an on-balance sheet credit equivalent amount by multiplying the
face amount of such item by a credit conversion factor ranging from 0.0% to
100.0% (depending upon the nature of the item); (ii) the credit equivalent
amount of each off-balance sheet item and each on-balance sheet asset must be
multiplied by a risk factor ranging from 0% to 100.0% (again depending on the
nature of the item); and (iii) the resulting amounts are added together and
constitute total risk-weighted assets. As of September 30, 1998, First Federal's
ratio of total capital to total risk-weighted assets was 18.46%.

         The OTS risk-based capital regulation also includes an interest rate
risk ("IRR") component that requires savings institutions that have greater than
normal IRR, when determining compliance with the risk-based capital
requirements, to maintain additional total capital. The OTS has, however,
indefinitely deferred enforcement of its IRR requirements.

         See "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION --
Capital Resources" for tables setting forth First Federal's compliance with its
regulatory capital requirements as of September 30, 1998.

         PROMPT CORRECTIVE ACTION

         FDICIA also established a system of prompt corrective action to resolve
the problems of undercapitalized institutions. Under this system, banking
regulators are required to take certain supervisory actions against
undercapitalized institutions, the severity of which depends upon the
institution's degree of capitalization. Under the OTS final rule implementing
the prompt corrective action provisions of FDICIA, an institution shall be
deemed to be (i) "well capitalized" if it has total risk-based capital of 10.0%
or more, has a Tier 1 risk-based capital ratio (core or leverage capital to
risk-weighted assets) of 6.0% or more, has a leverage capital ratio of 5.0% or
more and is not subject to any order, capital directive or prompt correction
action directive to meet and maintain a specific capital level for any capital
measure, (ii) "adequately capitalized" if it has a total risk-based capital
ratio of 8.0% or more, a Tier 1 risk-based ratio of 4.0% or more and a leverage
capital ratio of 4.0% or more (3.0% under certain circumstances) and does not
meet the definition of "well capitalized," (iii) "undercapitalized" if it has a
total risk-based capital ratio that is less than 8.0%, a Tier 1 risk-based
capital ratio that is less than 4.0% or a leverage capital ratio that is less
than 4.0% (3.0% in certain circumstances), (iv) "significantly undercapitalized"
if it has a total risk-based capital ratio that is less than 6.0%, a Tier 1
risk-based capital ratio that is less than 4.0% or a leverage capital ratio that
is less than 4.0% and (v) "critically undercapitalized" if it has a ratio of
tangible equity to total assets that is equal to or less than 3.0%. In addition,
under certain circumstances, a federal banking agency may reclassify a well
capitalized institution as adequately capitalized and may require an adequately
capitalized institution or an undercapitalized institution to comply with
supervisory actions as if it were in the next lower category (except that the
FDIC may not reclassify a significantly undercapitalized institution as
critically undercapitalized). At September 30, 1998, First Federal was
classified as a "well capitalized" institution.



                                       13
<PAGE>   15

         STANDARDS FOR SAFETY AND SOUNDNESS

         Under FDICIA, as amended by the Riegle Community Development and
Regulatory Improvements Act of 1994, the federal banking agencies were required
to establish safety and soundness standards for institutions under its
authority. The federal banking agencies, including the OTS, have adopted
Interagency Guidelines Establishing Standards for Safety and Soundness and final
rules establishing deadlines for submission and review of safety and soundness
compliance plans. 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 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. Additionally, the
OTS guidelines require savings institutions to maintain internal controls over
their asset quality and earnings. Under the 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. 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.

         DIVIDENDS AND OTHER CAPITAL DISTRIBUTION LIMITATIONS

         OTS regulations require First Federal to give the OTS 30 days' advance
notice of any proposed declaration of dividends to SouthFirst, and the OTS has
the authority under its supervisory powers to prohibit the payment of dividends
to SouthFirst. In addition, a savings institution may not declare or pay a cash
dividend on its capital stock if the effect thereof would be to reduce its
regulatory capital below the amount required for the liquidation account
established at the time of the institution's conversion from mutual to stock
form. First Federal's ability to pay dividends to SouthFirst is subject to the
financial performance of First Federal which is dependent upon, among other
things, the local economy, the success of First Federal's lending activities,
compliance of First Federal with applicable regulations, investment performance
and the ability to generate fee income.

         OTS regulations impose limitations upon all capital distributions by
savings institutions, such as cash dividends, payments to repurchase or
otherwise acquire its shares, payments to shareholders of another institution in
a cash-out merger and other distributions charged against capital. The
regulations establish three tiers of institutions, based primarily on an
institution's capital level. An institution that exceeds all fully phased-in
capital requirements before and after a proposed capital distribution (Tier 1
institution) and has not been advised by the OTS that it is in need of more than
normal supervision can, after prior notice but without the approval of the OTS,
make capital distributions during a calendar year equal to the greater of (i)
100% of its net income to date during the calendar year plus the amount that
would reduce by one-half its "surplus capital ratio" (the percentage by which an
association's capital-to-assets ratio exceeds the ratio of its fully phased-in
capital requirement to its assets) at the beginning of the calendar year, or
(ii) 75% of its net income over the most recent four quarter period. Any
additional capital distributions require prior regulatory approval. A Tier 2
association is an association that has capital equal to or in excess of its
minimum capital requirements but does not meet the fully phased-in capital
requirement both before and after the proposed distribution. A Tier 3
association is defined as an association that has capital less than its minimum
capital requirement before or after the proposed distribution. At September 30,
1998, First Federal was rated a Tier 1 institution. In the event First Federal's
capital falls below its fully phased-in requirement or the OTS notifies it that
it is in need of more than normal supervision, First Federal's ability to make
capital distributions could be restricted. In 



                                       14
<PAGE>   16

addition, the OTS could prohibit a proposed capital distribution by any
institution, which would otherwise be permitted by the regulation, if the OTS
determines that such distribution would constitute an unsafe or unsound
practice. Finally, under FDICIA, a savings association is prohibited from making
a capital distribution if, after making the distribution, the savings
association would be "undercapitalized" (i.e., not meet any one of its minimum
regulatory capital requirements).

         The OTS has proposed regulations that would simplify the existing
procedures governing capital distributions by savings institutions. Under the
proposed rule, the approval of the OTS would be required only for capital
distributions by an institution that is deemed to be in troubled condition or
that is undercapitalized or would be undercapitalized after the capital
distribution. A savings institution would be able to make a capital distribution
without notice to or approval of the OTS if it is not held by a savings and loan
holding company, is not deemed to be in troubled condition, has received either
of the two highest composite supervisory ratings and would continue to be
adequately capitalized after such distribution. Notice would have to be given to
the OTS by an institution that is held by a savings and loan holding company or
that had received a composite supervisory rating below the highest two composite
supervisory ratings. An institution's capital rating would be determined under
the prompt corrective action regulations. See " -- Prompt Corrective Action."

         QUALIFIED THRIFT LENDER TEST

         HOLA requires savings institutions to meet one of two Qualified Thrift
Lender ("QTL") tests, or suffer a number of regulatory sanctions, including
restrictions on business activities and on FHLB advances. To qualify as a QTL, a
savings institution must either (i) be deemed a "domestic building and loan
association" under the Internal Revenue Code (the "Code") by maintaining at
least 60% of its total assets in specified types of assets, including cash,
certain government securities, loans secured by and other assets related to
residential real property, educational loans, and investments in premises of the
institution or (ii) satisfy HOLA's QTL test by maintaining at least 65% of
"portfolio assets" in certain "Qualified Thrift Investments." For purposes of
HOLA's QTL test, portfolio assets are defined as total assets less intangible
assets, property used by a savings institution in its business and liquidity
investments in an amount not exceeding 20% of assets. "Qualified Thrift
Investments," as further defined by the Economic Growth Act (See --"Recent
Legislation"), generally include (i) loans made to purchase, refinance,
construct, improve or repair domestic residential or manufactured housing, (ii)
home equity loans, (iii) securities backed by or representing interest in
mortgages or domestic residential or manufactured housing, (iv) obligations
issued by the federal deposit insurance agencies, (v) small business loans, (vi)
credit card loans, (vii) education loans and (viii) shares in the FNMA, FHLMC
and FHLB owned by the savings institution. In addition, subject to a 20% of
portfolio assets limit, savings institutions are able to treat as Qualified
Thrift Investments 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 business in "credit needy" areas. At
September 30, 1998, First Federal qualified as a QTL.

         A savings association that does not maintain its status as a QTL in at
least nine out of every 12 months must either convert to a bank charter or
comply with the following restrictions on its operations: (i) the savings
association may not engage in any new activity or make any new investment,
directly or indirectly, unless such activity or investment is permissible for a
national bank and for a savings association; (ii) the branching powers of the
savings association are restricted to those of a national bank; (iii) the
savings association is not eligible to obtain any advances from its FHLB; and
(iv) payment of dividends by the savings association are subject to the rules
regarding payment of dividends by a national bank. Upon the expiration of three
years from the date the savings association 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 as promptly as can be
prudently done consistent with the safe and sound operation of the savings
association.



                                       15
<PAGE>   17

         LOANS TO ONE BORROWER

         Under HOLA, savings institutions are subject to the national bank
limits on loans to one borrower. Generally, a savings association may not make a
loan or extend credit to a single or related group of borrowers in excess of
15.0% of unimpaired capital and surplus. An additional amount may be lent, equal
to 10.0% of unimpaired capital and surplus, if such loan is secured by
readily-marketable collateral, which is defined to include certain securities
and bullion, but generally does not include real estate. First Federal has
received permission from the OTS to increase its loan to one borrower limits for
single-family residential builders, as permitted under applicable federal law
and regulations. The increased limit for these borrowers is 30.0% of unimpaired
capital and surplus of First Federal, with an aggregate limit to all such
borrowers equal to 150.0% of First Federal's unimpaired capital and surplus.

         LENDING GUIDELINES

         All financial institutions must adopt and maintain comprehensive
written real estate lending policies that are consistent with safe and sound
banking practices. These lending policies must reflect consideration of the
Interagency Guidelines for Real Estate Lending Policies adopted by the federal
banking agencies (the "Guidelines"). The Guidelines set forth, pursuant to the
mandates of FDICIA, uniform regulations prescribing standards for real estate
lending. Real estate lending is defined as the extension of credit secured by
liens on interests in real estate or made for the purpose of financing the
construction of a building or other improvements to real estate, regardless of
whether a lien has been taken on the property.

         The policies must address certain lending considerations set forth in
the Guidelines, including loan-to-value ("LTV") limits, loan administration
procedures, underwriting standards, portfolio diversification standards, and
documentation, approval and reporting requirements. These policies must also be
appropriate to the size of the institution and the nature and scope of its
operations, and must be reviewed and approved by the institution's board of
directors at least annually. The LTV ratio framework, with a LTV ratio being the
total amount of credit to be extended divided by the appraised value of the
property securing or being improved by the extension of credit plus the amount
of readily-marketable collateral or other acceptable collateral, must be
established for each category of real estate loans. If not a first lien, the
lender must combine all senior liens when calculating this ratio. The
Guidelines, among other things, establish the following supervisory LTV limits;
raw land (65.0%); land development (75.0%); construction (commercial,
multifamily and nonresidential) (80.0%); improved property (85.0%) and
one-to-four family residential (owner occupied) (no maximum ratio, however, any
LTV ratio in excess of 90.0% should require appropriate credit enhancement in
the form of either mortgage insurance or readily marketable collateral).

         Certain institutions can make real estate loans that do not conform
with the established LTV ratio limits up to 100.0% of the institutions total
capital. Within this aggregate limit, total loans for all commercial,
agricultural, multi-family and other non-one-to-four family residential
properties should not exceed 30.0% of total capital. An institution will come
under increased supervisory scrutiny as the total of such loans approaches these
levels. Certain loans are also exempt from the LTV ratios, such as loans
guaranteed by a government agency, loans to facilitate the sale of real estate
owned, and loans renewed, refinanced or restructured by the original lender(s)
to the same borrower(s) where there is no advancement of new funds.

         COMMUNITY REINVESTMENT

         Under the Community Reinvestment Act of 1977 ("CRA"), as implemented by
OTS regulations, a savings association has a continuing and affirmative
obligation consistent with its safe and sound operation to help meet the credit
needs of its entire community, including low and moderate income neighborhoods.
The CRA does not establish specific lending requirements or programs for
financial



                                       16
<PAGE>   18

institutions nor does it limit an institution's discretion to develop the types
of products and services that it believes are best suited to its particular
community, consistent with the CRA. The CRA requires the OTS, in connection with
its examination of a savings institution, to assess the institution's record of
meeting the credit needs of its community and to take such record into account
in its evaluation of certain applications by such institution. FIRREA amended
the CRA to require public disclosure of an institution's CRA rating and require
the OTS to provide a written evaluation of an institution's CRA performance
utilizing a four-tiered descriptive rating system in lieu of the existing
five-tiered numerical rating system. First Federal received a satisfactory
rating as a result of its latest evaluation on June 30, 1998.

         CONSUMER CREDIT REGULATION

         First Federal's mortgage lending activities are subject to the
provisions of various federal and state statutes, including, among others, the
Truth in Lending Act, the Equal Credit Opportunity Act, the Real Estate
Settlement Procedures Act, the Fair Housing Act, and the regulations promulgated
thereunder. These statutes and regulations, among other provisions, prohibit
discrimination, prohibit unfair and deceptive trade practices, require the
disclosure of certain basic information to mortgage borrowers concerning credit
terms and settlement costs, and otherwise regulate terms and conditions of
credit and the procedures by which credit is offered and administered. Many of
the above regulatory requirements are designed to protect the interests of
consumers, while others protect the owners or insurers of mortgage loans.
Failure to comply with these requirements can lead to administrative enforcement
actions, class action lawsuits and demands for restitution or loan rescission.

         TRANSACTIONS WITH AFFILIATES

         Generally, statutory restrictions on transactions with affiliates
require that transactions between a savings institution or its subsidiaries and
its affiliates be on terms as favorable to the institution as comparable
transactions with non-affiliates. In addition, extensions of credit and certain
other transactions with affiliates are restricted to an aggregate percentage of
a savings institution's capital, and collateral in specified amounts must
usually be provided by affiliates to receive loans from the institution.
Affiliates of First Federal include, among other things, SouthFirst and any
company which would be under common control with First Federal. In addition, a
savings association may not lend to any affiliate engaged in activities not
permissible for a bank holding company or acquire the securities of any
affiliate which is not a subsidiary. The OTS has the discretion to treat
subsidiaries of savings associations as affiliates on a case-by-case basis.

         A savings institution's authority to extend credit to its officers,
directors and 10% shareholders, as well as to entities that such persons
control, is governed by Sections 22(g) and 22(h) of the Federal Reserve Act and
Regulation O promulgated by the Federal Reserve Board. Among other things, these
regulations require such loans to be made on terms substantially similar to
those offered to unaffiliated individuals, place limits on the amount of loans a
savings institution may make to such persons based, in part, on the
institution's capital position, and require certain approval procedures to be
followed. OTS regulations, with minor variations, apply Regulation O to savings
institutions.

         BRANCHING BY FEDERAL ASSOCIATIONS

         The OTS's Policy Statement on Branching by Federal Savings Associations
permits interstate branching to the full extent permitted by statute (which is
essentially unlimited). This permits federal savings associations with
interstate networks to diversify their loan portfolios and lines of business.
The Policy Statement specifically states that OTS authority preempts any state
law purporting to regulate branching by federal associations.



                                       17
<PAGE>   19

         LIQUIDITY REQUIREMENTS

         All savings associations are required to maintain an average daily
balance of liquid assets equal to a certain percentage of the sum of its average
daily balance of net withdrawable deposit accounts and borrowings payable in one
year or less. The liquidity requirement may vary from time to time (between 4.0%
and 10.0%) depending upon economic conditions and savings flows of all savings
associations. At the present time, the required liquid asset ratio is 4.0%.

         Liquid assets for purposes of this ratio include specified short-term
assets (e.g., cash, certain time deposits, certain banker's acceptances and
short-term U.S. Government obligations), and long-term assets (e.g., U. S.
Government obligations of more than one and less than five years and state
agency obligations maturing in two years or less). The regulations governing
liquidity requirements include, within the definition of liquid assets, debt
securities hedged with forward commitments to purchase the obligation obtained
from (including a commitment represented by a repurchase agreement) members of
Bank of Primary Dealers in United States Government Securities or banks whose
accounts are insured by the FDIC, debt securities directly hedged with a short
financial future position, debt securities with a long put option and debt
securities that provide the holder with a right to redeem the security at the
stated or par value, regardless of the stated maturities of the securities.
FIRREA also authorized the OTS to designate as liquid assets certain
mortgage-related securities with less than one year to maturity. Monetary
penalties may be imposed upon associations for violations of liquidity
requirements.

         The OTS has recently revised its liquidity regulations to decrease the
burden of compliance with such rules. Specifically, the OTS has (1) reduced the
liquidity base by excluding withdrawable accounts payable in more than one year
from the definition of "net withdrawable accounts," (2) reduced the liquidity
requirement from 5% of net withdrawable accounts and short-term borrowings to
4%, (3) removed a requirement that short-term liquid assets constitute at least
1% of an association's average daily balance of net withdrawable deposit
accounts and current borrowings, and (4) expanded the categories of liquid
assets that may count toward satisfaction of the liquidity requirements.

         FEDERAL HOME LOAN BANK SYSTEM

         General. First Federal is a member of the FHLB System, which consists
of twelve regional FHLBs subject to supervision and regulation by the Federal
Housing Finance Board (the "FHFB"). The FHLBs maintain central credit facilities
primarily for member institutions.

         First Federal, as a member of the FHLB of Atlanta, is required to
acquire and hold shares of capital stock in the FHLB of Atlanta in an amount at
least equal to the greater of: (i) one percent of the aggregate outstanding
principal amount of its unpaid home mortgage loans, home purchase contracts and
similar obligations as of the beginning of each year or (ii) $500. First Federal
is in compliance with this requirement with an investment in stock of the FHLB
of Atlanta at September 30, 1998 of $1,375,000.

         Advances from Federal Home Loan Bank. Each FHLB serves as a reserve or
central bank for its members within its assigned region. It is funded from
proceeds derived from the sale of consolidated obligations of the FHLB System.
It makes advances (i.e., loans) to members in accordance with policies and
procedures established by the Board of Directors of the FHLB. Long term advances
may only be made for the purpose of providing funds for residential housing. At
September 30, 1998, First Federal had $16 million of advances outstanding from
the FHLB.

         As a result of FIRREA, the FHLBs are required to provide funds for the
resolution of troubled savings associations and to contribute to affordable
housing programs through direct loans or interest subsidies on advances targeted
for community investment and low and moderate income housing projects. These
contributions have adversely affected the level of dividends paid on FHLB stock
and could continue



                                       18
<PAGE>   20

to do so in the future. For the years ended September 30, 1998 and September 30,
1997, dividends were paid by the FHLB to First Federal in the amount of $102,846
and $41,219, respectively.

         FEDERAL RESERVE SYSTEM

         The Federal Reserve Board requires all depository institutions to
maintain non-interest bearing reserves at specified levels against their deposit
transaction accounts (e.g., primarily checking, NOW and Super NOW checking
accounts) and non-personal time deposits. Under current Federal Reserve Board
regulations, no reserves are required to be maintained on the first $4.4 million
of transaction accounts, while reserves equal to 3% must be maintained on the
next $49.3 million of transaction accounts, plus reserves equal to 10% of the
remainder. 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 reserve
requirement has the effect of reducing the amount of the institution's
interest-earning assets. At September 30, 1998, the total transaction accounts
of First Federal were below the minimum level for which the Federal Reserve
Board requires a reserve.

         Savings associations have authority to borrow from the Federal Reserve
Bank's "discount window," but Federal Reserve policy generally requires savings
associations to exhaust all OTS sources before borrowing from the Federal
Reserve System. First Federal did not have any such borrowings at September 30,
1998.


ITEM 2.  PROPERTIES

         First Federal conducts its business through its main office located in
Sylacauga, Alabama, branch offices located in Talladega, Clanton and
Centreville, Alabama, and loan production offices in Hoover, Dothan and Rainbow
City, Alabama. In addition, on November 24, 1998, First Federal purchased a
parcel of land in Birmingham, Alabama at a purchase price of $1,250,000. First
Federal is presently evaluating the costs of developing a new branch office at
this location. If it is determined that the site will be developed, construction
is expected to be completed in late 1999 or early 2000.

        The following table sets forth information relating to the offices of
SouthFirst, First Federal and Pension & Benefit at September 30, 1998. The total
net book value of the land and buildings owned by SouthFirst and its
subsidiaries at September 30, 1998 was approximately $3,047,000.
















                                       19
<PAGE>   21



<TABLE>
<CAPTION>
                                                                                    NET BOOK VALUE             DEPOSITS
                                            LEASED                                       AS OF                  AS OF
                LOCATION                   OR OWNED         DATE OPENED             SEPT. 30, 1998          SEPT. 30, 1998
                --------                   --------         -----------             --------------          --------------
                                                                                                (In thousands)
<S>                                         <C>              <C>                    <C>                     <C>    

SOUTHFIRST AND FIRST FEDERAL
    MAIN OFFICE
         126 North Norton Avenue            Owned            April 1966                $      764                $ 46,957
         Sylacauga, Alabama  35150

FIRST FEDERAL
    BRANCH OFFICES
         301 West North Street              Owned            April 1961                $      221                $ 17,957
         Talladega, Alabama  35160

         102 Fifth Street North             Owned            November 1997             $    1,492                $ 50,833
         Clanton, Alabama 35045

         125 Olan Heights                   Leased           November 1997                     --                $  8,087
               Shopping Center
         Centreville, Alabama 35042

    LOAN PRODUCTION OFFICES
         3055 Lorna Road                    Leased           March 1994                        --                      --
         Birmingham, Alabama  35216

         BrightLeaf Court                   Leased           April 1998                        --                      --
         Suite 20
         25 Honeysuckle Rd.
         Dothan, Alabama 36305

         111 Hollinsworth Ave.              Leased           January 1998                      --                      --
         Rainbow City, Alabama 35906

    OFFICE/STORAGE BUILDING
         North Norton Avenue                Owned(1)         November 1995             $      248                      --
         Sylacauga, Alabama  35150

PENSION & BENEFIT
         260 Commerce Street                Owned            April 1997                $      322                      --
         Third Floor
         Montgomery, Alabama 36101

TOTAL                                                                                  $3,047,000                $123,833
                                                                                       ==========                ========
</TABLE>

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

(1) In 1995, First Federal made improvements to a building adjacent to the main
office's parking lot with the intention of renting four offices to the general
public while using the remainder of the building for storage space for First
Federal. At September 30, 1998, one office was rented by SouthFirst's former
subsidiary, the Meta Company, and one office was rented to a local radio
station. The remaining two offices are utilized by First Federal's accounting
department. Meta and the station each remit a monthly amount of $750 to
SouthFirst.


ITEM 3.  LEGAL PROCEEDINGS

         In the normal course of business, SouthFirst and First Federal from
time to time are involved in legal proceedings. In one such proceeding, First
Federal management believes that an adverse judgment is reasonably possible and
estimates the pretax loss could be in the range of $50,000 to $100,000.
SouthFirst and First Federal management believe there are no pending or
threatened legal proceedings



                                       20
<PAGE>   22

which upon resolution are expected to have a material effect upon SouthFirst's
or First Federal's financial condition.

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

         No matter was submitted during the fourth quarter ended September 30,
1998 to a vote of security holders of SouthFirst.

                                     PART II

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

         As of November 2, 1998, SouthFirst's Common Stock was held by
approximately 417 persons. SouthFirst's Common Stock trades on the American
Stock Exchange, under the symbol "SZB." The following data reflects, by fiscal
quarter, the high and low sales price as well as cash dividends declared for
each quarter from October 1, 1996 through September 30, 1998:

<TABLE>
<CAPTION>
                                                                                  Cash
                                                                                  ----
                                                                                Dividends
                                                                                ---------
                                                 High Sale        Low Sale      Declared(1)
                                                 ---------        --------      ---------
    <S>                                          <C>             <C>            <C>     
    Fiscal Year Ended September 30, 1997
    ------------------------------------
    First Quarter ended December 31, 1996         $13 1/4          $12 1/4       $102,962
    Second Quarter ended March 31, 1997            14 1/2           12 7/8        102,962
    Third Quarter ended June 30, 1997              16               13 7/8        102,638
    Fourth Quarter ended September 30, 1997        18 1/4           15 7/8        102,950

    Fiscal Year Ended September 30, 1998                                                  
    ------------------------------------
    First Quarter ended December 31, 1997         $22 3/4          $18 3/8       $105,950
    Second Quarter ended March 31, 1998            22 5/8           21 5/8        145,192
    Third Quarter ended June 30, 1998              22 1/4           18 7/8        146,302
    Fourth Quarter ended September 30, 1998        18 7/8           15 7/8        146,302
</TABLE>


------------
(1) Certain cash dividends associated with SouthFirst's Management Recognition
    Plans and Employee Stock Option Plan shares are reflected as compensation
    expense in the consolidated financial statements. See "EXECUTIVE
    COMPENSATION -- Management Recognition Plans" and "-- Employee Stock
    Ownership Plan."

         Holders of SouthFirst Common Stock are entitled to receive such
dividends as may be declared by SouthFirst's Board of Directors. The amount and
frequency of cash dividends will be determined in the judgment of SouthFirst's
Board of Directors based upon a number of factors, including the company's
earnings, financial condition, capital requirements, and other relevant factors.
SouthFirst management presently intends to continue its present dividend
policies. See "BUSINESS -- Supervision and Regulation -- Regulation of First
Federal -- Dividends and Other Capital Distribution Limitations."

         The amount of dividends payable by First Federal is limited by law and
regulation. The need for First Federal to maintain adequate capital also limits
dividends that may be paid to SouthFirst. Although Federal Reserve policy could
restrict future dividends on SouthFirst Common Stock, such policy places no
current restrictions on such dividends. See "MANAGEMENT'S DISCUSSION AND
ANALYSIS OF FINANCIAL



                                       21
<PAGE>   23

CONDITION AND RESULTS OF OPERATIONS -- Capital Resources" and "BUSINESS --
Supervision and Regulation -- Regulation of First Federal -- Dividends and Other
Capital Distribution Limitations."

ITEM 6.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
         OF OPERATIONS

         The following discussion and analysis is designed to provide a better
understanding of the major factors which affected SouthFirst's results of
operations and financial condition for the referenced periods.

         The purpose of this discussion is to focus on significant changes in
the financial condition and results of SouthFirst during the two year period
ended September 30, 1998. This discussion and analysis is intended to supplement
and highlight information contained in the accompanying consolidated financial
statements and the selected financial data presented elsewhere herein.

ASSET/LIABILITY MANAGEMENT

         INTEREST RATE SENSITIVITY

         An integral aspect of the funds management of First Federal is the
maintenance of a reasonably balanced position between interest rate sensitive
assets and liabilities. First Federal's Asset/Liability Committee ("ALCO") is
charged with the responsibility of managing, to the degree prudently possible,
the bank's exposure to "interest rate risk," while attempting to provide a
stable and steadily increasing flow of depositors and borrowers and to seek
earnings enhancement opportunities. An asset or liability is said to be interest
rate sensitive within a specific period if it will mature or reprice within that
period. First Federal measures its interest rate risk as the ratio of cumulative
interest sensitivity gap to total interest earning assets ("ratio"). The ratio
is defined as the difference between the amount of interest-earning assets
maturing or repricing within a specific time period and the amount of
interest-bearing liabilities maturing or repricing within that same time period,
divided by the total interest earning assets. The ratio is positive when the
amount of interest rate sensitive assets exceeds the amount of interest
sensitive liabilities, and is negative when the amount of interest rate
sensitive liabilities exceeds the amount of interest rate sensitive assets.
Generally, during a period of rising interest rates, a negative ratio would
adversely affect net interest income, while a positive ratio would result in an
increase in net interest income. Conversely, during a period of falling interest
rates, a negative ratio would result in an increase in net interest income and a
positive ratio would adversely affect net interest income. Due to the nature of
First Federal's balance sheet structure and its use of the market approach to
pricing liabilities, First Federal's management and the First Federa Board of
Directors recognize that achieving a perfectly matched gap position in any given
time frame would be extremely rare. At September 30, 1998, First Federal had a
negative one-year cumulative ratio of (0.82%) and a negative five-year
cumulative ratio of (2.55%), as a result of which its net interest income could
be negatively affected by rising interest rates and positively affected by
falling interest rates. At September 30, 1997, First Federal had a negative
one-year cumulative ratio of (6.86%) and a positive five-year cumulative ratio
of 0.76%. During the stable interest rate environment of 1998 and 1997, First
Federal's interest rate spread remained fairly constant. Consistent with a
positive ratio during the increasing interest rate environment experienced in
late 1994 and 1995, when interest rates increased further and more rapidly on
interest-bearing liabilities than on interest-earning assets, First Federal
experienced a decrease in its interest rate spread. Conversely, consistent with
a negative ratio, during the declining interest rate environment experienced
from 1991 through late 1994, when interest rates declined further and more
rapidly on interest-bearing liabilities than on interest-earning assets, First
Federal experienced an increase in its interest rate spread.



                                       22
<PAGE>   24

         There are other factors that may affect the interest rate sensitivity
of First Federal's assets and liabilities. These factors generally are difficult
to quantify but can have a significant impact on First Federal when interest
rates change. Such factors include features in adjustable rate loans that limit
the changes in interest rates on a short-term basis and over the life of the
loan. First Federal's portfolio of one-to-four family residential mortgage loans
included $34.4 million and $14.7 million (32% and 19% of First Federal's total
loan portfolio) of adjustable rate loans at September 30, 1998 and September 30,
1997, respectively. These loans have restrictions limiting interest rate changes
to 1.0% or 2.0% per year and 6.0% over the life of the loan. In a rapidly
declining or rising interest rate environment, these restrictions could have a
material effect on interest income by slowing the overall response of the
portfolio to market movements. ALCO utilizes the "Asset and Liability Management
Report" prepared by Morgan Keegan & Company, Inc. (the "Morgan Keegan Analysis")
in order to assist First Federal in determining First Federal's gap and interest
rate position. Through use of the Morgan Keegan Analysis, ALCO analyzed the
effect of an increase or decrease of up to 400 basis points on the market value
of First Federal's portfolio equity ("MVPE") at September 30, 1998 and September
30, 1997. At a 400 basis point increase, First Federal's MVPE increased
approximately $133,000 and $107,000 at September 30, 1998 and September 30,
1997, respectively, and, at a 400 basis point decrease, First Federal's MVPE
decreased approximately $111,000 and $146,000 at September 30, 1998 and
September 30, 1997, respectively. Management determined that these changes in
MVPE were acceptable.

         The following table sets forth information regarding the projected
maturities and repricing of the major asset and liability categories of First
Federal as of September 30, 1998 and September 30, 1997. Maturity and repricing
dates have been projected by applying the assumptions set forth below as to
contractual maturity and repricing dates. Classifications of items in the table
are different from those presented in other tables and the financial statements
and accompanying notes included therein.


              [THE REMAINDER OF THIS PAGE INTENTIONALLY LEFT BLANK]














                                       23
<PAGE>   25


<TABLE>
<CAPTION>

                                                       Interest Rate Sensitivity Gap
                                                                                          

                                                           At September 30, 1998                                        
                            -------------------------------------------------------------------------------------------- 

                              One                                                    Four to                            
                              year         One to        Two to        Three to        Five       Over                  
                             or less      two years    three years    four years      years     five years     Total    
                             -------      ---------    -----------    ----------      -----     ----------     -----    
                                                                                                   (In thousands)
<S>                          <C>          <C>          <C>            <C>            <C>        <C>           <C>       
Interest-earning assets:
 Mortgage loans              $ 56,758      $  7,290      $  6,890      $  6,539      $ 5,012      $12,520     $ 95,009  
 All other loans                2,668         1,854         2,034         2,233          792           --        9,581  
 Collateralized mortgage
   obligations                  4,171           160            --            --           --           --        4,331  
 Mortgage-backed
   securities                  13,432           696           748           805          865        9,992       26,538  
 Investments(1)                 4,052            --            --            --          108        1,795        5,955  
                             --------      --------      --------      --------      -------      -------     --------  
   Total interest
      earning assets         $ 81,081      $ 10,000      $  9,672      $  9,577      $ 6,777      $24,307     $141,414  
                             ========      ========      ========      ========      =======      =======     ========  

Interest-bearing
 liabilities:

 Deposits                      70,452        29,375         4,375           233          106       19,343      123,884  
 Borrowed funds                11,788         1,500         1,526         1,355           --           --       16,169  
                             --------      --------      --------      --------      -------      -------     --------  

   Total interest
     bearing
     liabilities             $ 82,241      $ 30,874      $  5,900      $  1,589      $   106      $19,343     $140,053  
                             ========      ========      ========      ========      =======      =======     ========  

Interest
  sensitivity gap            $ (1,160)     $ 20,874      $  3,771      $  7,988      $ 6,671      $ 4,964     $  1,361  

Cumulative interest
  sensitivity gap            $ (1,160)     $(22,034)     $(18,263)     $(10,274)     $(3,603)     $ 1,361     $  1,361  

Ratio of cumulative
 interest sensitivity gap
 to total interest
 earning assets                 (0.82)%      (15.58)%      (12.91)%       (7.27)%      (2.55)%       0.96%        0.96% 

Ratio of cumulative
 interest
 sensitivity gap to
 total assets of
 $158,518                       (0.73)%      (13.90)%      (11.52)%       (6.48)%      (2.27)%       0.86%        0.86% 




<CAPTION>
                                                     Interest Rate Sensitivity Gap

                                                         At September 30, 1997
                               ------------------------------------------------------------------------------------

                                  One                                               Four to
                                 year         One to      Two to       Three to       five      Over  
                                or less      two years  three years   four years     years    five years     Total
                                -------      ---------  -----------   ----------     -----    ----------     -----
                             
<S>                             <C>          <C>        <C>           <C>           <C>       <C>           <C>    
Interest-earning assets:
 Mortgage loans                 $ 39,130      $ 5,301      $ 4,578      $ 3,949      $3,399     $12,649     $69,006
 All other loans                     676          744          817          439          --          --       2,676
 Collateralized mortgage
   obligations                     5,586          511           44           --          --          --       6,141
 Mortgage-backed
   securities                      3,264          209          225          241         259         553       4,731
 Investments(1)                    1,951        1,473           --           --          --       2,353       5,777
                                --------      -------      -------      -------      ------     -------     -------
   Total interest
      earning assets            $ 50,607      $ 8,228      $ 5,664      $ 4,629      $3,658     $15,555     $88,332
                                ========      =======      =======      =======      ======     =======     =======

Interest-bearing
 liabilities:

 Deposits                         39,585        5,640        5,636        1,300       1,300       7,092      60,553
 Borrowed funds                   17,081          662          318          303         289          --      18,653
                                --------      -------      -------      -------      ------     -------     -------

   Total interest
     bearing
     liabilities                $ 56,666      $ 6,302      $ 5,954      $ 1,603      $1,589     $ 7,092     $79,206
                                ========      =======      =======      =======      ======     =======     =======

Interest
  sensitivity gap               $ (6,059)     $ 1,926      $  (290)     $ 3,026      $2,069     $ 8,463     $ 9,135

Cumulative interest
  sensitivity gap               $ (6,059)     $(4,133)     $(4,423)     $(1,397)     $  672     $ 9,135     $ 9,135

Ratio of cumulative
 interest sensitivity gap
 to total interest
 earning assets                    (6.86)%      (4.68)%      (5.01)%      (1.58)%      0.76%      10.34%      10.34%

Ratio of cumulative
 interest
 sensitivity gap to
 total assets of
 $158,518                          (6.33)%      (4.31)%      (4.62)%      (1.46)%      0.70%       9.54%       9.54%
</TABLE>


---------------------
(1) Includes investments in overnight deposits.



                                       24
<PAGE>   26



         The Morgan Keegan Analysis for 1998 and 1997 and the preceding table
were prepared based upon the contractual terms of the asset or liability and
with the following assumptions regarding prepayment of loans, CMOs and
mortgage-backed securities, and decay rates of deposits. These prepayment and
decay rate assumptions are management's estimates based on expectations of
future interest rates. Fixed rate mortgage loans are assumed to prepay at 8%.
Adjustable rate loans, CMOs and mortgage-backed securities are presented in the
period in which they next reprice. All other loans (principally consumer
installment loans) are presented at their contractual maturities. Fixed rate
CMOs are assumed to prepay at rates ranging from 12% to 18%. The decay rates for
money market demand accounts are assumed to be 33% for the first year and 18%
thereafter. The decay rates for passbook accounts are assumed to be 56% for the
first year and 10% thereafter and the decay rates for NOW accounts are assumed
to be 18% for the first year and 33% thereafter. Certificate accounts and
borrowed funds are presented at their contractual maturities. Certain
shortcomings are inherent in the method of analysis presented in the table
above. Although certain assets and liabilities may have similar maturities or
periods of repricing, they may react in different degrees to changes in the
market interest rates. The interest rates on certain types of assets and
liabilities may fluctuate in advance of changes in market interest rates, while
rates on other types of assets and liabilities may lag behind changes in market
interest rates. Certain assets, such as ARMs, generally have features which
restrict changes in interest rates on a short-term basis and over the life of
the asset. In the event of a change in interest rates, prepayments and early
withdrawal levels would cause significant deviations in the table. Additionally,
an increased credit risk may result if the ability of many borrowers to service
their debt decreases in the event of an interest rate increase. A majority of
the adjustable rate loans in First Federal's portfolio contain conditions which
restrict the periodic change in interest rates. See "BUSINESS -- Business of
First Federal -- Residential Lending."

         INTEREST RATE RISK STRATEGY

         First Federal has employed various strategies intended to minimize the
adverse effect of interest rate risk on future operations by providing a better
match between the interest rate sensitivity of its assets and liabilities. First
Federal's strategies are intended to stabilize long term net interest income by
protecting its interest rate spread against decreases and increases in interest
rates. To offset the interest rate risk associated with holding a substantial
amount of fixed rate loans and having a predominantly short-term certificate of
deposit base, First Federal maintains a portfolio of residential adjustable-rate
mortgage loans that reprice in less than one year. The amount of loans in this
portfolio was equal to $10,047,000 at September 30, 1998 and $3,049,824 at
September 30, 1997. First Federal also sells a significant portion of its fixed
rate loan originations with maturities of greater than 15 years in the secondary
markets, and directs excess cash flow into short-term and adjustable rate
investment securities. Diversification into more interest-sensitive mortgage
loans and construction loans in the Birmingham area has also served to reduce
First Federal's interest rate risk exposure.

         EFFECTS OF INFLATION AND CHANGING PRICES

         Inflation generally increases the costs of funds and operating
overhead, and, to the extent loans and other assets bear variable rates, the
yields on such assets. Unlike most industrial companies, virtually all of the
assets and liabilities of a financial institution are monetary in nature. As a
result, interest rates generally have a more significant impact on the
performance of a financial institution than the effects of general levels of
inflation. Although interest rates do not necessarily move in the same direction
or to the same extent as the prices of goods and services, increases in
inflation generally have resulted in increased interest rates. In addition,
inflation affects a financial institution's cost of goods and services
purchased, the cost of salaries and benefits, occupancy expense, and similar
items. Inflation and related increases in interest rates generally decrease the
market value of investments and loans held and may adversely affect liquidity,
earnings, and 



                                       25
<PAGE>   27

shareholders' equity. Mortgage originations and refinancings tend to slow as
interest rates increase and would likely reduce First Federal's earnings from
such activities. Further, First Federal's income from the sale of residential
mortgage loans in the secondary market would also likely decrease if interest
rates increased.

AVERAGE BALANCE, INTEREST, YIELDS AND RATES

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

         The table also presents information for the periods indicated with
respect to the difference between the average yield earned on interest-earning
assets and average rate paid on interest-bearing liabilities, or "interest rate
spread," which savings institutions have traditionally used as an indicator of
profitability. Another indicator of an institution's net interest income is its
"net yield on total interest-earning assets," which is its net interest income
divided by the average balance of interest-earning assets. Net interest income
is affected by the interest rate spread and by the relative amounts of
interest-earning assets and interest-bearing liabilities. When interest-earning
assets approximate or exceed interest-bearing liabilities, any positive interest
rate spread will generate net interest income.

              [THE REMAINDER OF THIS PAGE INTENTIONALLY LEFT BLANK]







                                       26

<PAGE>   28

<TABLE>
<CAPTION>
                                                         AVERAGE BALANCE, INTEREST, YIELDS AND RATES
                                                                                                    Year ended September 30,      
                                   ------------------------------------------------------------------------------------------------
                                                      1998                                                 1997                    
                                   ----------------------------------------------   -----------------------------------------------

 
                                       Average                             Yield/         Average                           Yield/ 
                                       Balance          Interest            Cost          Balance          Interest          Cost  
                                       -------          --------           ------         -------          --------         -----  
<S>                                  <C>               <C>                  <C>         <C>               <C>               <C>    
Interest earning assets:
                                                                                                                                   
Total investment securities         $ 36,608,820      $ 2,825,283           7.72%       $18,766,230       $1,330,015        7.09%  
Loans receivable                     100,740,509        8,272,834           8.21%        68,847,596        5,763,382        8.37%  
                                     -----------      -----------           -----        ----------        ---------        ----   
Total interest earning assets        137,349,329       11,098,117           8.08%        87,613,826        7,093,397        8.10%  
Allowance for loan losses              (761,418)                                          (267,587)                                
Cash and amounts due from                                                                                                          
  depository institutions             13,521,914                                          3,314,123                                

Premises and equipment                 3,243,193                                          1,803,898                                

Foreclosed real estate                    79,991                                             52,572                                

Accrued interest receivable              992,932                                            536,705                                

Other assets                           2,870,586                                          1,163,510                                

Investments in Affiliates                143,373                                            224,174                                
                                    ------------                                         ----------                                

   Total assets                     $157,439,900                                        $ 94,463,22                                
                                    ============                                         ==========                                

Interest bearing liabilities:

Deposits:
NOW accounts                         $10,661,585         $281,676           2.66%        $6,501,600       $  194,669        2.99%  
Money market demand                      331,268            6,676           2.02%           460,120           10,049        2.18%  
Passbook savings                      14,163,764          327,840           2.31%         9,612,487          249,157        2.59%  
Certificates of deposit, other                                                                                                     
 than Jumbos                          89,379,909        4,741,697           5.31%        43,579,206        2,288,858        5.25%  
Jumbos                                 2,155,655           58,240           2.70%         1,547,064           76,827        4.97%  
                                     -----------       ----------           ----         ----------        ---------        ----   



<CAPTION>

                                           ---------------------------------------------
                                                                1996
                                           ---------------------------------------------

 
                                            Average                              Yield/
                                            Balance             Interest          Cost
                                            -------             --------         -----
<S>                                        <C>                 <C>                <C>  
Interest earning assets:
                                                                                 
Total investment securities                $24,717,374         $1,732,093         7.01%
Loans receivable                            58,902,758          4,888,183         8.30%
                                            ----------         ----------         ----
Total interest earning assets               83,620,132          6,620,276         7.92%
Allowance for loan losses                     (259,024)
Cash and amounts due from                                                                     
  depository institutions                    1,752,025                                        

Premises and equipment                       1,686,613

Foreclosed real estate                          26,479

Accrued interest receivable                    478,798

Other assets                                   344,974

Investments in Affiliates                      224,635
                                           -----------

   Total assets                            $87,882,937
                                            ==========

Interest bearing liabilities:

Deposits:
NOW accounts                               $ 6,634,502         $  247,025         3.72%
Money market demand                            474,725              5,152         1.09%
Passbook savings                             9,724,844            279,365         2.87%
Certificates of deposit, other                                                 
 than Jumbos                                44,264,201          2,417,380         5.46%
Jumbos                                       1,319,337             57,115         4.33%
                                           -----------         ----------         ----
</TABLE>



                                       27
<PAGE>   29


<TABLE>
<CAPTION>
                                                               AVERAGE BALANCE, INTEREST, YIELDS AND RATES
                                                                                                   Year ended September 30,
                                        ----------------------------------------------------------------------------------------
                                                      1998                                             1997                    
                                        ------------------------------------------     -----------------------------------------

 
                                          Average                          Yield/         Average                         Yield/
                                          Balance           Interest        Cost          Balance          Interest        Cost  
                                          -------           --------       ------         -------          --------       ------  
<S>                                     <C>               <C>              <C>          <C>               <C>             <C>   
                                                                                                                                

  Total interest-bearing deposits        $116,692,181       $5,416,128       4.64%       $61,700,477       $2,819,560      4.57% 
Borrowed funds                             17,810,529        1,148,782       6.45%        15,838,355          981,737      6.20% 
                                         ------------       ----------       ----        -----------       ----------      ----  
   Total interest-bearing liabilities     134,502,710        6,564,910       4.88%        77,538,832        3,801,297      4.90% 
Non-interest bearing demand                                                                                                      
   deposits                                 3,183,937                                      1,364,221                             
Advances by borrowers for                                                                                                        
   property taxes                             341,284                                        311,372                             
Accrued interest payable                      813,599                                        650,236                             
Income taxes payable                        1,366,979                                        656,951                             
Accrued expenses and other                                                                                                       
  liabilities                               1,214,851                                        733,320                             
                                         ------------                                    -----------                             
   Total liabilities                      141,423,360                                     81,254,932                             
Stockholders' equity                       16,016,540                                     13,208,290                             
                                         ------------                                    -----------                             
   Total liabilities & stockholders' 
    equity                               $157,439,900                                    $94,463,221                             
                                         ============                                    ===========                             
Net interest income                                         $4,533,207                                     $3,292,100            
                                                            ==========                                     ==========            
Interest rate spread                                                         3.20%                                         3.19% 
                                                                           ======                                        ======  
Net yield on total interest earning
    assets                                                                   3.30%                                         3.76% 
                                                                           ======                                        ======  
Average interest-earning assets to                                                                                               
   average total interest-bearing 
   liabilities ratio                                                       102.12%                                       112.99%
                                                                           ======                                        ====== 



<CAPTION>

                                                                                       
                                        ------------------------------------------------
                                                             1996                      
                                        ------------------------------------------------

 
                                          Average                              Yield/  
                                          Balance            Interest           Cost  
                                         ---------          ----------        -------- 
<S>                                     <C>                  <C>              <C>     
                                                                                       
  Total interest-bearing deposits        $62,417,409         $3,006,037         4.82%
Borrowed funds                             8,978,744            553,372         6.16%
                                         -----------         ----------         ----
   Total interest-bearing liabilities     71,396,353          3,559,409         4.99%
Non-interest bearing demand                                                             
   deposits                                1,222,123                                    
Advances by borrowers for                                                               
   property taxes                            328,858                                    
Accrued interest payable                     655,018
Income taxes payable                         463,812
Accrued expenses and other                                                              
  liabilities                                238,643                                    
                                         -----------
   Total liabilities                      74,304,807
Stockholders' equity                      13,578,131
                                         -----------
   Total liabilities & stockholders' 
    equity                               $87,882,937                                    
                                         ===========
Net interest income                                          $3,060,867
                                                             ==========
Interest rate spread                                                            2.93%
                                                                              ======
Net yield on total interest earning
    assets                                                                      3.66%
                                                                              ======
Average interest-earning assets to                                                      
   average total interest-bearing 
   liabilities ratio                                                          117.12%
                                                                              ======       
</TABLE>



                                       28

<PAGE>   30


FINANCIAL CONDITION

         INVESTMENT SECURITIES

         Investment securities held to maturity were $971,000, $162,000 and
$154,000 at September 30, 1998, September 30, 1997 and September 30, 1996,
respectively. The increase of $809,000 in 1998 was due primarily to the
acquisition of First Federal Savings and Loan Association of Chilton County
during the first fiscal quarter. First Federal's portfolio of investment
securities available for sale totaled $36,824,000 and $16,666,000 at September
30, 1998 and September 30, 1997, respectively.

         The composition of First Federal's total investment securities
portfolio reflects First Federal's former investment strategy of providing
acceptable levels of interest income from portfolio yields while maintaining
level of liquidity which would allow First Federal a degree of control over its
interest rate position. In previous years, First Federal invested primarily in
investment grade CMOs and mortgage-backed securities because of their liquidity,
credit quality and yield characteristics. The yields, values and duration of
such securities generally vary with interest rates, prepayment levels, and
general economic conditions and, as a result, the values of such instruments may
be more volatile than other instruments with similar maturities. Such securities
also may have longer stated maturities than other securities, which may result
in further price volatility. First Federal made purchases of CMOs amounting to
$3,329,000 in 1994, along with purchases of mortgage-backed securities amounting
to $204,000 in 1994.

         With First Federal's purchase of the construction loan portfolio of
another Alabama thrift institution in April of 1994, First Federal revised its
investment strategy, deciding to curtail its purchases of CMOs and
mortgage-backed securities and utilize principal repayments on these securities
to fund construction loans. Accordingly, First Federal did not purchase any CMOs
or mortgage-backed securities from 1994 through 1997. However, in 1998 First
Federal acquired approximately $466,000 in CMOs and $16,101,000 in
mortgage-backed securities, as a result of First Federal's acquisition of
Chilton County in October 1998. In addition, as a result of the excess cash on
hand from the Chilton County acquisition, First Federal purchased approximately
$18,670,000 in mortgage-backed securities in 1998.

         Principal repayments on both CMOs and mortgage-backed securities for
the years ended September 30, 1998, 1997, and 1996 were $15,292,000, $3,093,000,
and $7,247,000, respectively. As of September 30, 1998 First Federal had an
investment in FHLB agencies of $150,000 compared to $2,000,000 as of September
30, 1997. The decrease is due to approximately $2,000,000 in agencies being
called in fiscal 1998. At September 30, 1998, First Federal had investments of
approximately $4,854,000 in equity securities such as FHLB stock, FHLMC stock,
other common stock, and mutual funds.

           The following table indicates the amortized cost of the portfolio of
investment securities held to maturity at September 30, 1998, September 30, 1997
and September 30, 1996:





                                       29
<PAGE>   31


<TABLE>
<CAPTION>
                                                                        Amortized Cost
                                                                         September 30,
                                                               -----------------------------------
                                                                1998            1997          1996
                                                                        (In thousands)
<S>                                                             <C>             <C>          <C> 
Investment Securities Held to Maturity:
      U.S. Government agency...............................     $499             $162         $154
      Mortgage-backed securities...........................       90               --           --
      Collateralized mortgage obligations..................       --               --           --
      Other................................................      382               --           --
                                                                ----            -----        -----
               Total investment securities                                                            
               held to maturity............................    $ 971            $ 162        $ 154
                                                               =====            =====        =====
</TABLE>


         The following table indicates the fair value of the portfolio of
investment securities available for sale at September 30, 1998, 1997 and 1996:

<TABLE>
<CAPTION>
                                                                                      Fair Value
                                                                                      September 30,
                                                                      ------------------------------------------
                                                                       1998              1997             1996
                                                                       ----              ----             ----
                                                                                 (In thousands)
<S>                                                                   <C>               <C>              <C>    
Investment Securities Available for Sale:
     U.S. Government agency..................................          $1,101            $2,008           $4,697
     Mortgage-backed securities..............................          26,538             4,751            6,091
     Collateralized mortgage obligations.....................           4,331             6,141            7,878
     Other...................................................           4,854             3,766            3,127
                                                                     --------             -----            -----
        Total investment securities available for sale.......         $36,824           $16,666          $21,793
                                                                      =======           =======          =======
</TABLE>



         At September 30, 1998, First Federal owned CMOs totaling $4,331,000.
These securities were all backed by federal agency guaranteed mortgages except
for two issues, in the amount of $230,000, which are privately issued mortgage
pass-through certificates. One issue, totaling $417,000, bears a fixed rate of
interest; the remainder are variable rate instruments.

         The mortgage-backed securities portfolio, totaling $26,538,000 at
September 30, 1998, consists of fixed rate mortgages in the amount of
$13,889,000 and ARMs in the amount of $12,649,000. At the time of purchase,
First Federal looks at various prepayment speeds and makes the purchase based on
the ability to accept the yield and average life based on both increasing and
decreasing prepayment speeds.













                                       30
<PAGE>   32


                  The following table presents the contractual maturities and
weighted average yields of investment securities, other than equity securities,
available for sale at September 30, 1998:

<TABLE>
<CAPTION>
                                                                                 Maturities of
                                                                            Investment Securities
                                                                        After one    After five
                                                        Within           through       through            After
                                                       one year        five years     ten years         ten years
                                                       --------        ----------     ---------         ---------
                                                                             (In thousands)
<S>                                                    <C>             <C>            <C>            <C>      
U.S. Government agencies, excluding
    mortgage-backed securities....................      $    --           $350         $    751         $      --
Mortgage-backed securities........................           --            163            9,236            17,139
Collateralized mortgage obligations...............          417             --              537             3,377
Other securities..................................           --             --               --                --
                                                        -------          -----         --------          --------
    Total investment securities
         available for sale.......................      $   417          $ 513         $ 10,524          $ 20,516
                                                        =======          =====         ========          ========
</TABLE>



<TABLE>
<CAPTION>
                                                                        Weighted Average Yields(1)
                                                                        (Taxable equivalent basis)
                                                                       After one          After five
                                                           Within       through             through       After
                                                          one year     five years          ten years     ten years
                                                          --------     ----------          ---------     ---------
                                                                          (In thousands)
<S>                                                       <C>          <C>                 <C>           <C>  
U.S. Government agencies, excluding                                                                    
  mortgage-backed securities.................                  --        7.20%                6.66%            --
Mortgage-backed securities...................                  --        7.66%                6.13%         5.55%
Collateralized mortgage obligations..........               6.31%           --                5.24%         6.10%
Other securities.............................                  --           --                   --            --
                                                            -----        -----                -----
    Total weighted average yield.............               6.31%        7.35%                6.12%         5.64%
                                                            =====        =====                =====         =====
</TABLE>


-------------------
(1) None of First Federal's investment securities are tax exempt.

    Investment securities held to maturity at September 30, 1998 generally have
contractual maturities of one year or less.

         The maturities for the CMOs and mortgage-backed securities presented
above represent contractual maturities of such securities. Due to the nature of
these securities, the timing and amount of principal repayments is generally
unpredictable. However, assuming current prepayment rates and normal, required
principal repayments, the following table sets forth certain information
regarding the expected principal payments, carrying values, fair values and
weighted average yields of First Federal's CMOs and mortgage-backed securities
at September 30, 1998:










                                       31
<PAGE>   33



<TABLE>
<CAPTION>
                                      Principal payments expected during the fiscal
                                                year ending September 30,                        At September 30, 1998
                                ----------------------------------------------------------   ------------------------------
                                                          (Dollar amounts in thousands)
                                                                                                                   Weighted
                                                                                           Carrying     Fair        Average
                                1999       2000      2001      2002      2003   Thereafter   Value      Value        Yield
                                ----       ----      ----      ----      ----   ----------   -----      -----        -----
<S>                             <C>       <C>       <C>       <C>       <C>     <C>        <C>         <C>         <C>  
Collateralized  mortgage
   obligations .............    $2,276    $  187    $  114    $   65    $  279    $1,404    $ 4,325    $ 4,331       6.02%
Mortgage-backed
   securities ..............    $6,160    $4,602    $3,409    $2,594    $1,991    $7,603    $26,359    $26,538       5.81%
Agencies ...................    $  828        --        --        --    $  250        --    $ 1,078    $ 1,101       6.65%
</TABLE>



         LOANS

         Total loans of $105,322,000 at September 30, 1998 reflected an increase
of $33,356,000 (46.3%) compared to September 30, 1997. Total loans of
$71,966,000 at September 30, 1997 reflected an increase of 14.9% from total
loans of $62,653,000 at September 30, 1996. The increase from fiscal 1997 to
fiscal 1998 was largely due to the loans acquired in connection with the
purchase of Chilton County in October of 1997. First Federal has experienced
strong loan demand in its one-to-four family construction loan portfolio since
First Federal's purchase of the construction loan portfolio and the opening of a
loan production office in 1994. See "BUSINESS -- Business of First Federal --
Construction Lending."

         One-to-four family real estate mortgage loans increased $6,257,000
(15%) from September 30, 1995 to September 30, 1996. The increase from September
30, 1996 to September 30, 1997 was $5,005,000 (10%). The increase from September
30, 1997 to September 30, 1998 was $24,601,000 (46.5%). First Federal
aggressively pursues real estate mortgage loans within its own market area. In
addition to originating mortgage loans for its own portfolio, First Federal also
actively originates residential mortgage loans which are sold in the secondary
market, with servicing released. First Federal sells a significant portion of
all residential mortgage loans with terms greater than 15 years. For the most
part, such sales are composed of residential mortgage loans with terms of 30
years. Proceeds from loan sales were $11,743,000, $4,629,000 and $4,360,000 for
the years ended September 30, 1998, 1997, and 1996, respectively. See "FINANCIAL
STATEMENTS -- Consolidated Statements of Cash Flows." Had First Federal not sold
residential mortgage loans over the past several years, the one-to-four family
real estate mortgage loan portfolio would have increased by a larger margin than
the percentage indicated above. The relatively stable interest rate market for
much of 1998 and 1997 resulted in an increase in volume of loans sold during
these periods. The following table presents the composition of the loan
portfolio for each of the past five years:



                                       32
<PAGE>   34


<TABLE>
<CAPTION>
                                                     Loan Portfolio Composition (dollar
                                                              amounts in thousands)

                                                                 At September 30,
                       -----------------------------------------------------------------------------------------------------
                             1998                   1997                1996              1995                   1994
                       -----------------------------------------------------------------------------------------------------

                                    Percent              Percent           Percent               Percent             Percent
                          Amount    of Total    Amount   of Total  Amount  of Total   Amount     of Total   Amount  of Total
                          ------    --------    ------   --------  ------  --------   ------     --------   ------  --------
<S>                       <C>       <C>         <C>      <C>      <C>      <C>        <C>        <C>       <C>      <C>   
Real estate mortgage 
   loans:
   One-to-four family     $73,239     70.02%    $52,855    73.74%  $47,981   76.89%   $41,593     77.70%   $39,989   79.82%
   Multi-family and
     commercial             1,837      1.76         390     0.54       485    0.78        535      1.00        585    1.17
Construction loans         20,833     19.92      22,880    31.92    17,717   28.39     13,495     25.21     10,715   21.39
Savings account loans       1,988      1.90         826     1.15       753    1.21        873      1.63        739    1.48
Installment loans           7,593      7.26       2,044     2.85     2,129    3.41      2,736      5.11      3,163    6.31
Second Mortgage Loans       6,216      5.94          --       --        --      --         --        --         --      --
                         --------               -------            -------            -------              -------
   Total loans           $111,706               $78,995            $69,065            $59,232              $55,191        
                         ========               =======            =======            =======              =======

Less:
   Loans in process       (6,102)     (5.83)    (6,778)    (9.46)  $(6,195)   (9.93)  $(5,243)     (9.79)  $(4,670)   (9.32)
   Discounts and                                                                                                            
   other, net               (282)     (0.27)      (251)    (0.35)     (217)   (0.35)     (190)     (0.35)     (189)   (0.38)
   Allowance for loan                                                                                              
    losses:                 (732)     (0.70)      (284)    (0.40)     (251)   (0.40)     (266)     (0.50)     (231)   (0.46)
                         -------     ------     -------    ------  -------   ------   -------     ------   -------   ------
                                                                                                        
   Total loans, net     $104,590     100.00%   $71,682    100.00%  $62,402   100.00%  $53,533     100.00%  $50,101   100.00%
                        ========     ======    =======    ======   =======   ======   =======     ======   =======   ======
</TABLE>



         The following table shows the maturity of First Federal's loan
portfolio at September 30, 1998, based upon contractual maturity dates. Demand
loans, loans having no schedule of repayment and no stated maturity and
overdrafts are reflected as due during the twelve months ended September 30,
1998. The table below does not include an estimate of prepayments, the
occurrence of which would significantly shortens the average life of all
mortgage loans and cause First Federal's actual repayment to differ from that
shown below.

<TABLE>
<CAPTION>
                                                           Loan Maturities
                                Due during the year
                                  ending Sept 30,
                           -------------------------------
                                                              Due after    Due after    Due After    Due After                 
                            1999         2000        2001     3-5 years    5-10 years  10-15 years   15 years       Total
                            ----         ----        ----     ---------    ----------  -----------   ---------      -----

                                                                   (In thousands)
<S>                        <C>          <C>         <C>       <C>          <C>         <C>          <C>            <C>     
Real estate mortgage       $ 2,319      $  953      $2,697      $5,911      $16,364      $22,743      $25,798      $ 76,785
Construction loans(1)       15,533          --          --          --           --           --           --        15,533
All other loans              3,489       1,457       1,646       3,916        1,133          631           --        12,272
                           -------      ------      ------      ------      -------      -------      -------      --------
Total                      $21,341      $2,410      $4,343      $9,827      $17,497      $23,374      $25,798      $104,590
                           =======      ======      ======      ======      =======      =======      =======      ========
</TABLE>


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

(1) The maturity period for construction loans is typically one year. If the
home is not sold at the maturity date, however, the loan may be extended for an
additional six months provided that the builder restructures the loan to provide
for principal reduction or arranges for permanent financing which will pay off
the construction loan.



                                       33
<PAGE>   35




         The following tables set forth, at September 30, 1998 and September 30,
1997, the dollar amount of loans due after September 30, 1998 and September 30,
1997, respectively, based upon whether such loans have fixed interest rates or
adjustable interest rates:


<TABLE>
<CAPTION>
                                                               September 30, 1998
                                               --------------------------------------------------
                                                  Fixed            Floating or                   
                                                   Rate           Adjustable Rate         Total
                                                   ----           ---------------         -----
                                                                  (In thousands)
<S>                                            <C>                <C>                   <C>     
Real estate mortgage loans..........           $ 57,595               $ 34,375          $ 91,970
Commercial loans....................                348                     --               348
Savings and installments loans......             12,272                     --            12,272
                                               --------               --------          --------
   Total............................           $ 70,215               $ 34,375          $104,590
                                               ========               ========          ========
</TABLE>



<TABLE>
<CAPTION>
                                                                September 30, 1997
                                              --------------------------------------------------
                                                  Fixed             Floating or                   
                                                   Rate           Adjustable Rate         Total
                                                   ----           ---------------         -----
                                                                   (In thousands)
<S>                                            <C>                <C>                   <C>    
Real estate mortgage loans..........           $ 53,806                $14,665           $68,471
Commercial loans....................                390                     --               390
Savings and installments loans......              2,821                     --             2,821
                                               --------                -------           -------
   Total............................           $ 57,017                $14,665           $71,682
                                               ========                =======           =======
</TABLE>



     The following table sets forth First Federal's loan originations, sales and
principal repayments for the periods indicated.

<TABLE>
<CAPTION>
                                                             Year ended September 30,
                                                      -------------------------------------
                                                          1998         1997         1996
                                                                (In thousands)
<S>                                                      <C>          <C>          <C>    
Loan Originations:
     Real estate mortgage and construction loans ..      $61,629      $53,227      $46,096
     All other loans ..............................        7,820        3,483        1,125
                                                         -------      -------      -------
        Total .....................................       69,449       56,710       47,221
                                                         =======      =======      =======
Portfolio Loan Purchases:
     Real estate mortgage loans ...................           --           --           --
                                                         =======      =======      =======
Portfolio Loan Sales Proceeds:
     Real estate mortgage loans ...................       11,743        4,485        4,360
                                                         =======      =======      =======
Principal Repayments:
     Real estate mortgage and construction loans ..       43,040       35,751       34,928
     All other loans ..............................        6,825        3,470          399
                                                         -------      -------      -------
     Total ........................................      $49,865      $39,221      $35,327
                                                         =======      =======      =======
</TABLE>



                                       34
<PAGE>   36
                   ALLOWANCE FOR LOAN LOSSES AND RISK ELEMENTS

          The performance of loans is evaluated primarily on the basis of a
review of each customer relationship over a period of time and the judgment of
lending officers as to the ability of borrowers to meet the repayment terms of
loans. If there is reasonable doubt as to the repayment of a loan in accordance
with the agreed terms, the loan may be placed on a nonaccrual basis pending the
sale of any collateral or a determination as to whether sources of repayment
exist. Generally, delinquency of 90 days or more creates reasonable doubt as to
repayment. This action may be taken even though the financial condition of the
borrower or the collateral may be sufficient to ultimately reduce or satisfy the
obligation. Generally, when a loan is placed on a nonaccrual basis, all payments
are applied to reduce principal to the extent necessary to eliminate doubt as to
the repayment of the loan. Interest income on a nonaccrual loan is recognized
only on a cash basis. See "--Nonperforming Assets."

          Lending officers are responsible for the ongoing review and
administration of each particular loan. As such, they make the initial
identification of loans which present some difficulty in collection or where
circumstances indicate that the probability of loss exists. The responsibilities
of the lending officers include the collection effort on a delinquent loan.
Senior management and the First Federal Board are informed of the status of
delinquent loans on a monthly basis. Senior management reviews the allowance for
loan losses and makes recommendations to the First Federal Board as to loan
charge-offs on a monthly basis.

          At September 30, 1998, September 30, 1997 and September 30, 1996,
loans accounted for on a nonaccrual basis were approximately $1,734,000,
$116,000, and $203,000, respectively, or 1.6%, 0.16%, and 0.32% of the total
loans outstanding, net of unearned income. The balances of accruing loans past
due 90 days or more as to principal and interest payments were $394,000,
$591,000, and $343,000 at September 30, 1998, September 30, 1997 and September
30, 1996, respectively.

          The allowance for loan losses represents management's assessment of
the risk associated with extending credit and its evaluation of the quality of
the loan portfolio. Management analyzes the loan portfolio to determine the
adequacy of the allowance for loan losses and the appropriate provision required
to maintain a level considered adequate to absorb anticipated loan losses. In
assessing the adequacy of the allowance, management reviews the size, quality
and risk of loans in the portfolio. Management also considers such factors as
First Federal's historical loan loss experience, the level, severity, and trend
of criticized assets, the distribution of loans by risk class, and various
qualitative factors such as current and anticipated economic conditions.

          First Federal began construction lending activities in March of 1994.
As of September 30, 1998, First Federal has not experienced any significant
losses on the construction loan portfolio. Since these lending activities are
fairly new to First Federal, First Federal does not have the same historical
data available for construction loans as for other loans. Due to the
concentration of these loans, a default by certain construction loan borrowers,
or other financial difficulty, could result in a significant addition to the
allowance for loan losses.

          While it is First Federal's policy to charge off loans in the period
in which a loss is considered probable, there are additional risks of future
losses which cannot be quantified precisely or attributed to particular loans or
classes of loans. Because these risks include the state of the economy,
management's judgment as to the adequacy of the allowance is necessarily
approximate and imprecise.



                                       35

<PAGE>   37



          In assessing the adequacy of the allowance, management relies
predominately on its ongoing review of the loan portfolio, which is undertaken
both to ascertain whether there are probable losses which must be charged off
and to assess the risk characteristics of the portfolio in the aggregate. This
review takes into consideration the judgments of the responsible lending
officers, senior management and those of bank regulatory agencies that review
the loan portfolio as part of First Federal's examination process. Specific
percentages are allocated to each loan type. Management recognizes that there is
more risk traditionally associated with commercial and consumer lending as
compared to real estate mortgage lending; correspondingly, a greater allocation
is made for commercial and consumer loans than real estate mortgage loans. While
all information available is used by management to recognize losses in the loan
portfolio, there can be no assurances that future additions to the allowance
will not be necessary. First Federal's Board of Directors reviews the
assessments of management in determining the adequacy of the allowance for loan
losses. Generally, the only loans, including construction loans, which are
classified are loans which are greater than 90 days delinquent. However, the
Board of Directors may also classify loans less than 90 days delinquent should
such classification be considered necessary.

          First Federal's allowance for loan losses is also subject to
regulatory examinations and determinations as to adequacy, which may take into
account such factors as the methodology used to calculate the allowance for loan
loss reserves and the size of the loan loss reserve in comparison to a group of
peer banks identified by the regulators. During its routine examinations of
banks, the OTS has, from time to time, required additions to banks' provisions
for loan losses and allowances for loan losses as the regulators' credit
evaluations and allowance for loan loss methodology have differed from those of
the management of such banks. Such regulatory examinations have focused on loan
quality, particularly that of real estate loans. First Federal attempts to
reduce the risks of real estate lending through maximum loan-to-value
requirements as well as systematic cash flow and initial customer credit history
analyses. See "SUPERVISION AND REGULATION."

          Management believes that the $732,000 in allowance for loan losses at
September 30, 1998, is adequate to absorb known risks in the portfolio. No
assurance can be given, however, that adverse economic circumstances will not
result in increased losses in First Federal's loan portfolio. At September 30,
1998, $155,000 of the allowance for loan losses was reserved for possible losses
on construction loans, $370,000 was reserved for possible losses on real estate
mortgage loans, and the remaining 207,000 was reserved for all other loan
classifications.

          The following table summarizes the levels of the allowance for loan
losses at the end of the last five years:


                                       36

<PAGE>   38

<TABLE>
<CAPTION>
                                                                          Year Ended September 30,
                                           1998                1997               1996              1995              1994
                                           ----                ----               ----              ----              ----

                                                                        (Dollar amounts in thousands)
<S>                                        <C>                 <C>                <C>               <C>               <C> 
Balance at beginning of period             $284                $251               $266              $231              $189
Clanton Balance at Acquisition              488                  --                 --                --                --
Charge-offs:
      Real estate                            16                  --                  3                 1                10
Installment                                  82                   4                 14                14                 6
                                           ----                ----               ----              ----              ----
           Total charge-offs                 98                   4                 17                15                16
                                           ----                ----               ----              ----              ----
Recoveries:
      Real estate mortgage                    4                  --                 --                --                --
      Installment                             9                   1                  2                21                 8
                                           ----                ----               ----              ----              ----
           Total recoveries                  13                   1                  2                21                 8
                                           ----                ----               ----              ----              ----
Net loans (recovered) charged off            85                   3               (15)               (6)                 8
</TABLE>

<TABLE>
<S>                                         <C>                   <C>                <C>               <C>               <C>   
Provisions for loan losses                        45                  36                  -                29                50
                                            --------              ------             ------            ------            ------
Balance at end of period                    $    732              $  284             $  251            $  266            $  231
                                            ========              ======             ======            ======            ======
Ratio of net charge-offs to total loans
  outstanding net of unearned income            0.08%               0.00%             (0.02%)           (0.01%)            0.02%
                                            ========              ======             ======            ======            ======
 Ratio of allowance for loan losses
  to loans outstanding, net of
  unearned income                               0.66%               0.39%              0.40%             0.49%             0.46%
                                            ========              ======             ======            ======            ======

Total Loans Outstanding                     $104,590              71,967             62,653            53,799            50,332
</TABLE>


          As indicated in the above table, First Federal substantially increased
its loan loss allowance in 1998 from the levels of the preceding four years.
This increase was primarily due to the acquisition of Chilton County in October
of 1997.

          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 an indication of
future losses and does not restrict the use of the allowance to absorb losses in
any category.


<TABLE>
<CAPTION>
                                                                     At September 30,
                           --------------------------------------------------------------------------------------------------
                                      1998                                 1997                                1996
                           --------------------------          ----------------------------        --------------------------
                                     Percent of loans                      Percent of loans                  Percent of loans
                                     in each category                      in each category                  in each category
                           Amount     to total loans           Amount       to total loans         Amount     to total loans
                           ------    ----------------          ------      ----------------        ------    ----------------
                                                               (Dollar amounts in thousands)
<S>                        <C>       <C>                       <C>         <C>                     <C>       <C>   
Real estate mortgage                                                                                                
   loans                    510           69.67%                217             82.75%              171            68.13%
All other loans             222           30.33%                 67             17.25%               80            31.87%
                           ----           -----                ----             -----              ----            -----
   Total allowance
      for loan losses      $732             100%               $284               100%             $251              100%
                           ====           =====                ====             =====              ====            =====
</TABLE>


          On October 1, 1994, First Federal adopted the Financial Accounting
Standards Board's Statement No. 114, "Accounting by Creditors for Impairment of
a Loan" ("FAS 114"), as amended by FAS 118. FAS 114 addresses the accounting by
creditors for impairment of certain loans and requires that impaired loans be
measured based on the present value of expected future cash flows discounted at
the loan's effective interest rate or at the loan's observable market price or
the fair value of the collateral if the loan is collateral dependent. Under FAS
114, creditors are permitted to use existing methods for recognizing interest
income on impaired loans. FAS 114 requires that an entity disclose its policy
for recognizing interest income on impaired loans, including how cash receipts
are recorded. The effect of the adoption of FAS 114 was immaterial. At September
30, 1998, the total recorded investment in impaired loans, all of which had
allowances determined in accordance with SFAS No. 114 and No. 118 was
approximately $221,000. The average recorded investment in impaired loans
amounted to approximately $227,000 for the year ended September 30, 1998. The
allowance for loan losses related to impaired loans was approximately $221,000
for fiscal 1998. Interest income on impaired loans of approximately $1,000 was
booked in 1998. No loans were considered impaired at September 30, 1997.


                                       37

<PAGE>   39



            NONPERFORMING ASSETS

          First Federal has policies, procedures and underwriting guidelines
intended to assist in maintaining the overall quality of its loan portfolio.
First Federal monitors its delinquency levels for any adverse trends.
Nonperforming assets consist of loans on nonaccrual status, accruing loans which
are past due 90 days or more, and foreclosed real estate.

          First Federal's policy generally is to place a loan on nonaccrual
status when there is reasonable doubt as to the repayment of the loan in
accordance with the agreed terms. Generally, delinquency of 90 days or more
creates reasonable doubt as to repayment. At the time a loan is placed on
nonaccrual status, interest previously accrued but not collected is reversed and
charged against current earnings. Income is subsequently recognized only to the
extent that cash payments are received until, in management's judgment, the
borrower is able to make periodic interest and principal payments and the loan
is no longer delinquent and is returned to accrual status.

          Nonperforming assets were $2,128,000, $707,000, and $546,000 at
September 30, 1998, September 30, 1997, and September 30, 1996, respectively.
The increase in 1998 was due to the acquisition of Chilton County. The increases
in the levels of non-performing assets from 1996 to 1997 coincides with
the increase in loan balances. As a percentage of total loans, nonperforming
assets continue to be at levels which management considers to be acceptable and
commensurate with First Federal's conservative lending policies.

          An analysis of the components of nonperforming assets at September 30,
1998, September 30, 1997 and September 30, 1996 is presented in the following
table:


                                       38

<PAGE>   40





<TABLE>
<CAPTION>
                                                                    At September 30,
                                                        ------------------------------------
                                                          1998           1997          1996
                                                        --------       -------       -------
                                                                    (In thousands)
<S>                                                     <C>            <C>           <C>    
Loans accounted for on a non-accrual basis:
Real estate mortgage loans                              $    756       $    80       $   147
All other loans                                              978            36            56
                                                        --------       -------       -------
   Total                                                $  1,734       $   116       $   203
                                                        --------       -------       -------
Accruing loans which are past due 90 days or more:
Real estate mortgage loans                              $    394       $   577       $   342
All other loans                                                0            14             1
                                                        --------       -------       -------
    Total                                               $    394       $   591       $   343
                                                        --------       -------       -------
Total of non-accrual and 90 days past
   due loans                                            $  2,128       $   707       $   546
Foreclosed real estate (net of related
   loss provisions)                                           --            --            --
                                                        --------       -------       -------
Total non-performing assets                             $  2,128       $   707       $   546
                                                        ========       =======       =======
Nonaccrual and 90 days past due loans
   as a % of total loans                                    2.03%         0.98%         0.87%
                                                        ========       =======       =======
Nonperforming assets as a % of total
   loans                                                    2.03%         0.98%         0.87%
                                                        ========       =======       =======
Total Loans Outstanding                                 $104,590       $71,967       $62,653
                                                        ========       =======       =======
</TABLE>

          Management regularly reviews and monitors the loan portfolio in a
effort to identify borrowers experiencing financial difficulties, but such
measures are subject to uncertainties that cannot be predicted.

          DEPOSITS

                    Total deposits increased in fiscal 1998 by $63,331,000
(104.6%) to $123,883,000. In fiscal 1997, total deposits decreased 5.5%,from
$64,095,000 to $60,552,000. Non-interest-bearing demand deposits were
$3,436,000, $1,256,000, and $1,131,000, while total interest-bearing deposits
were $120,447,000, $59,348,000, and $63,008,000 at September 30, 1998, September
30, 1997, and September 30, 1996, respectively.

                    First Federal's deposit mix at September 30, 1998 increased
compared to year-end 1997. NOW accounts increased $5,679,000 (100.0%), while
money market demand accounts decreased $77,000 (19.4%). Certificates of deposits
other than jumbo certificates of deposit, which are certificates of deposit
greater than or equal to $100,000 with specially negotiated rates ("Jumbos"),
increased $48,632,000 (115.6%). Non-interest-bearing demand deposits increased
$2,180,000 (173.6%). During 1998, certificates of deposit, excluding Jumbos,
comprised approximately 73.1% of total deposits while low cost funds, including
NOW accounts, money market demand accounts, and passbook savings accounts, made


                                       39

<PAGE>   41



up 24.2% of First Federal's total deposits. Jumbos comprised 2.7% of total
deposits at September 30, 1998.

     The composition of total deposits for the last three fiscal years is
presented in the following table:


<TABLE>
<CAPTION>
                                                                     September 30,
                                     -----------------------------------------------------------------------------
                                              1998                       1997                      1996
                                     -----------------------  -------------------------  -------------------------
                                                              (Dollar amounts in thousands)
                                                   Percent                    Percent                   Percent
                                                    change                     change                    change
                                                  from prior                 from prior                 from prior
                                       Amount      year-end     Amount        year-end    Amount        year-end
                                     ---------    ----------  ---------      ----------  --------       ----------
<S>                                  <C>          <C>          <C>           <C>         <C>            <C>     
Non-Interest bearing                                                                                              
   Demand deposits                   $   3,436      173.57%   $   1,256         15.73%   $  1,131        (28.30)%
Interest bearing deposits:                                                                                        
   NOW accounts                         11,354      100.00        5,675        (15.80)      6,697         (6.93)
   Money market demand                     324      (19.40)         401        (13.39)        463         (7.95)
   Passbook savings                     14,769       57.45        9,380         (4.88)      9,861          1.63
   Certificates of deposit other
   than Jumbos                          90,698      115.60       42,066         (5.24)     44,395          3.17
   Jumbos                                3,302       86.55        1,770         14.34       1,548         85.17
                                     ---------      ------    ---------         -----    --------          ---- 
   Total interest bearing deposits     120,447      103.13       59,348         (5.81)     62,964          2.76
                                     ---------      ------    ---------         -----    --------          ---- 
         Total deposits              $ 123,883      104.59%   $  60,552         (5.53)%  $ 64,095          2.01%
                                     =========      ======    =========         =====    ========          ==== 
</TABLE>



         The following tables set forth the distribution of First Federal's
deposit accounts at the dates indicated and the weighted average nominal
interest rates on each category of deposits presented based on average balances:


                                       40

<PAGE>   42




<TABLE>
<CAPTION>
                                                 At September 30, 1998
                                 -----------------------------------------------------
                                                                                                                  Percentage
                                                                                                                      of
Interest                                                                                                             total
  Rate         Term                             Category                      Minimum            Balance            Balances
--------       ----                             --------                      -------           --------          ----------
<S>          <C>                 <C>                                          <C>               <C>               <C>  

                                         (In thousands except minimum balance)                                            
0.00%        None                Non-interest bearing demand                  $     50          $  3,436              2.77%
2.55%        None                NOW accounts                                      250            11,286              9.11

2.13%        None                Non-profit                                        100                68               .05
2.13%        None                Money market checking                           2,500               324              0.26
2.58%        None                Passbook savings                                   50            11,286             10.46

2.55%        None                Statement savings                                 100             1,811              1.46
4.75%        3 months            Fixed-term fixed rate certificate               2,500               591              0.48
5.38%        6 months            Fixed-term fixed rate certificate               2,500            13,207             10.66
5.58%        12months            Fixed-term fixed rate certificate                 500            18,950             15.30
5.73%        18 months           Fixed-term fixed rate certificate                 500             5,050              4.08
                                 
5.68%        IRA                 Fixed-term fixed rate certificate                 250            19,198             15.50

5.96%        30 months           Fixed-term fixed rate certificate                 500            28,382             22.91
5.87%        1 month             Fixed-term fixed rate certificate             100,000             3,302              2.67
                                            
6.59%        4 year              Fixed-term fixed rate certificate               1,500             3,464              2.80
6.65%        5 year              Fixed-term fixed rate certificate               1,500             1,856              1.50
6.25%        IRA                 Fixed-term fixed rate certificate                 250                --                --
                                                                                                --------            ------
                                                                                                $123,883            100.00%
                                                                                                ========            ======
</TABLE>


<TABLE>
<CAPTION>
                                                 At September 30, 1998
                                 -----------------------------------------------------
                                                                                                                  Percentage
                                                                                                                      of
Interest                                                                                                             total
  Rate         Term                             Category                      Minimum            Balance            Balances
--------       ----                             --------                      -------           --------          ----------
<S>          <C>                 <C>                                          <C>               <C>               <C>  

                                         (In thousands except minimum balance)                                            
0.00%        None                Non-interest bearing demand                  $     50          $  1,258              2.08%
2.13%        None                NOW accounts                                      250             5,676              9.37

2.13%        None                Money market checking                           2,500               401              0.66
2.13%        None                Passbook savings                                   50             9,380             15.49

4.75%        3 months            Fixed-term fixed rate certificate               2,500               327              0.54
5.38%        6 months            Fixed-term fixed rate certificate               2,500             9,955             16.44
5.50%        12months            Fixed-term fixed rate certificate                 500             8,643             14.27
5.75%        18 months           Fixed-term fixed rate certificate                 500             2,916              4.82
                       
5.50%        IRA                 Fixed-term fixed rate certificate                 250             8,024             13.25
                       
6.25%        30 months           Fixed-term fixed rate certificate                 500             9,882             16.32
5.63%        1 month             Fixed-term fixed rate certificate             100,000             1,770              2.92
6.25%        4 year              Fixed-term fixed rate certificate               1,500               759              1.25
6.25%        5 year              Fixed-term fixed rate certificate               1,500             1,562              2.58
6.25%        IRA                 Fixed-term fixed rate certificate                 250                --                --
                                                                                                --------           -------
                                                                                                $ 60,552            100.00%
                                                                                                ========           =======
</TABLE>



                                       41
<PAGE>   43

               Information about the average balances of interest-bearing demand
deposits and time deposits for the periods indicated based upon average balances
is provided below:

<TABLE>
<CAPTION>
                                                                Year ended September 30,
                                  ----------------------------------------------------------------------------------------------
                                              1998                             1997                                1996
                                  -------------------------         ------------------------           -------------------------
                                                                (Dollar amounts in thousands)
                                  Interest                          Interest                           Interest                  
                                   bearing                           bearing                            bearing                  
                                   demand            Time            demand           Time              demand            Time
                                  deposits         deposits         deposits        deposits           deposits         deposits
                                  --------         --------         --------        --------           --------         --------
<S>                               <C>              <C>              <C>             <C>                <C>              <C>    
Average balance                    $25,157          $91,536          $16,574         $45,126            $16,835          $45,583
Average rate                          2.46%            5.24%            2.74%           5.24%              3.15%            5.43%
</TABLE>



               The following table presents changes in deposits for the periods
indicated:


<TABLE>
<CAPTION>
                                                                        For the year ended September 30,
                                                     -----------------------------------------------------------------
                                                       1998                1997             1996                 1995
                                                     =======              ======           ======               ======

                                                                  (Dollar amounts in thousands)
<S>                                                  <C>                  <C>              <C>                  <C>   
Opening balance                                       60,552              64,095           62,832               64,774
Deposits Acquired through Acquisition                 64,608
Net deposits (withdrawals)                            (4,331)             (5,364)            (626)              (3,901)
Interest credited on deposits                          3,055               1,821            1,889                1,959
Ending balance                                       123,884              60,552           64,095               62,832
                                                     =======              ======           ======               ======
To decrease (increase) in deposits                    63,332              (3,543)           1,263               (1,942)
                                                     =======              ======           ======               ======
Percentage decrease (increase)                        104.59%              (5.53)%           2.01%               (3.00)%
                                                     =======              ======           ======               ======
</TABLE>





                                       42
<PAGE>   44



                  The following table presents, by various interest rate
categories, the amount of certificate accounts outstanding at the end of the
last three fiscal years:

<TABLE>
<CAPTION>
                                                   Year ended September 30,
                                --------------------------------------------------------
                                    1998                     1997                 1996
                                  ---------                ---------            --------
                                                         (In thousands)
Interest Rate
-------------
<S>                             <C>                        <C>                 <C>      
2.00-2.99%                      $        --                $     106           $     119

3.00.-3.99%                              --                       --                 276

4.00-4.99%                              591                      450               1,507

5.00.-5.99%                          64,168                   37,276              38,106

6.00-6.99%                           26,693                    4,927               4,889

7.00.-7.99%                           2,548                    1,079               1,046
                                  ---------                ---------            --------
         Total                    $  94,000                $  43,838            $ 45,943
                                  =========                =========            ========
</TABLE>



     There were no certificates of deposit bearing an interest rate less than
4.0% at September 30, 1998. At September 30, 1998, First Federal had outstanding
approximately $94.0 million in certificate accounts that mature as follows:

<TABLE>
<CAPTION>
                                                 Amount due
                 -------------------------------------------------------------------------
                     Less         One         Two     Three      Four                                 
                 than one      to two    to three   to four   to five          
                     year       years       years     years     years   Thereafter   Total
                 --------      ------    --------   -------   -------   ----------   -----
                                             (In thousands)
Interest Rate
<S>              <C>          <C>        <C>        <C>       <C>       <C>          <C>        
2.00-2.99%       $    --      $    --      $   --      $ --      $ --       $--     $    --    

3.00.-3.99%           --           --          --        --        --        --          --    

4.00-4.99%           591           --          --        --        --        --         591    

5.00.-5.99%       47,437       13,567       2,851       169       145        --      64,169    

6.00-6.99%        16,045        9,123       1,219       183       122        --      26,692    

7.00.-7.99%        2,507           41          --        --        --        --       2,548    
                 -------      -------      ------      ----      ----       ---     -------    
      Total      $66,580      $22,731      $4,070      $352      $267       $--     $94,000    
                 =======      =======      ======      ====      ====       ===     =======    
</TABLE>                                                                    



                                       43
<PAGE>   45

         Certificates of deposit of $100,000 or more, other than Jumbos, mature
as follows as of September 30, 1998:

<TABLE>
<CAPTION>
                                                  Amount due                                          
                  -------------------------------------------------------------------------------
                      Less         One          Two     Three     Four                                      
                  than one      to two     to three   to four  to five                                              
                      year       years        years     years    years     Thereafter       Total  
                  --------      ------     --------   -------  -------     ----------      ------
                                              (In thousands)                                        
Interest Rate                                                                               
<S>               <C>           <C>        <C>        <C>      <C>         <C>             <C>                            
2.00-2.99%          $   --      $   --         $ --      $ --      $--            $--      $   --                             

3.00.-3.99%             --          --           --        --       --             --          --                             

4.00-4.99%             222          --           --        --       --             --         222                             

5.00.-5.99%          2,345       1,197          201        --       --             --       3,743                             

6.00-6.99%           5,055       2,067          422       100       --             --       7,644                             

7.00.-7.99%            959          --           --        --       --             --         959                             
                    ------      ------         ----      ----      ---             --      ------                             
         Total      $8,581      $3,264         $623      $100      $--            $--      12,568                             
                    ======      ======         ====      ====      ===             ==      ======                             
</TABLE>



         Jumbos mature as follows as of September 30, 1998:


<TABLE>
<CAPTION>
                                                  Amount due                                          
                  -------------------------------------------------------------------------------
                      Less         One          Two     Three     Four                                      
                  than one      to two     to three   to four  to five                                              
                      year       years        years     years    years     Thereafter       Total  
                  --------      ------     --------   -------  -------     ----------      ------
                                              (In thousands)                                        
Interest Rate                                                                               
-------------
<S>               <C>           <C>        <C>        <C>      <C>         <C>             <C>                            
2.00-2.99%          $   --       --        $     --   $    --  $   --             $--      $   --                 

3.00.-3.99%             --       --                        --      --              --          --                 

4.00-4.99%              --       --              --        --      --              --          --         

5.00.-5.99%            906       --              --        --      --              --         906         
                                                                                                                 
6.00-6.99%           1,990      406              --        --      --              --       2,396         
                                                                                                                 
7.00.-7.99%             --       --              --        --      --              --          --         
                    ------      ---        --------   -------  ------             ---      ------         
         Total       2,896      406        $     --   $    --  $   --              --      $3,302         
                    ======      ===        ========   =======  ======             ===      ======         
                                                                                  
</TABLE>


                                       44
<PAGE>   46

         The following table presents the maturities of certificates of deposit
as of September 30, 1998, September 30, 1997 and September 30, 1996:


<TABLE>
<CAPTION>
                                              Maturities of Time Deposits
                                                     September 30,
                                          -----------------------------------
                                            1998         1997          1996
                                            ----         ----          ----
                                                    (In thousands)
<S>                                       <C>          <C>          <C>
Three months or less                      $ 2,433      $ 9,189      $ 8,099

After three within six months              12,417       10,799       10,655

After six within twelve months             51,730       15,138       15,302

One year to two years                      22,731        5,385        8,115

Two years to three years                    4,070        2,991        2,372

Three years to four years                     352          314        1,106

Four years to five years                      267           22          294
                                          -------      -------      -------
    Total                                 $94,000      $48,838      $45,943
                                          =======      =======      =======
Weighted average rate on all
  certificates of deposit 
  at period-end                              5.73%        5.58%        5.53%
                                          =======      =======      =======
</TABLE>



SHORT-TERM BORROWINGS

         First Federal has a line of credit of up to $4,000,000 which bears
interest at the prime lending rate plus 1%. The line of credit requires monthly
interest payments and payments of the outstanding balance in October 1998. The
prime lending rate was 8.50% at September 30, 1998 and the outstanding balance
on the line of credit was $5,000.

         Borrowings also include borrowings from the FHLB of Atlanta (See "--
Liquidity"). The balances outstanding at September 30, 1998, and September 30,
1997 were $16,044,000 and $17,058,000, respectively. These balances included
advances with both fixed and variable interest rates, which averaged 5.86% and
5.99% at September 30, 1998 and September 30, 1997, respectively.

CAPITAL RESOURCES

         STOCKHOLDERS EQUITY

         SouthFirst's consolidated shareholders' equity was $15,671,000 and
$13,623,000 at September 30, 1998 and September 30, 1997, respectively. The 1998
increase was primarily due to the acquisition of Chilton County during the year.

         During 1998, cash dividends of $543,746, or $0.575 per share, were
declared on SouthFirst Common Stock. During 1997, cash dividends of $414,188, or
$0.50 per share were declared. The cash dividends declared during 1996 included
a special dividend of $2.00 per share, paid in connection with SouthFirst's
equity management programs. SouthFirst's special dividend in 1996 should be
considered a non-recurring event and, although SouthFirst plans to continue a
dividend payout policy that allows it

                                       45
<PAGE>   47


to maintain adequate capital to support future growth and capital adequacy, the
1996 dividend payout ratio, which was based in part on excess capital, cannot be
viewed as a guarantee of future dividend payments. Management believes that a
strong capital position is vital to the continued profitability of First Federal
and provides a foundation for future growth as well as promoting depositor and
investor confidence in the institution.

         Certain financial ratios for First Federal as of the end of the most
recent three fiscal years and presented in the following table:


<TABLE>
<CAPTION>
                                                  Equity and Assets Ratio
                                                        September 30,
                                               --------------------------------
                                                1998       1997         1996
                                                ----       ----         ----
<S>                                            <C>        <C>          <C>
Return on average assets                        0.40%      0.52%         (0.02)%

Return on average stockholder's equity          3.96%      3.75%         (0.12)%

Common dividend payout ratio                   85.65%     83.59%       (11,513)%

Average shareholders' equity to average        10.17%     13.98%         15.45%
  assets
</TABLE>


         FIRREA and the implementing regulations of the OTS, which became
effective on December 7, 1989, changed the capital requirements applicable to
thrifts, including First Federal, and the consequences for failing to comply
with such standards. The capital standards include (i) a core capital
requirement, (ii) a tangible capital requirement, and (iii) a risk-based capital
requirement. FIRREA specifies such capital requirements and states that such
standards shall be no less stringent than the capital standards applicable to
national banks. The OTS has issued guidelines identifying minimum regulatory
tangible capital equal to 1.50% of adjusted total assets, a minimum 3.0% core
capital ratio, and a minimum risk-based capital of 8.0% of risk-weighted assets.
See "SUPERVISION AND REGULATION -- Regulatory Capital Requirements." As shown in
the table below, First Federal was in compliance with these regulatory capital
requirements at September 30, 1998 and September 30, 1997.



                                       46
<PAGE>   48



<TABLE>
<CAPTION>
                                           At September 30, 1998                                 At September 30, 1997
                           -------------------------------------------------       ------------------------------------------------
                              Tangible             Core           Risk-based        Tangible            Core             Risk-based
                              Capital             Capital           Capital          Capital           Capital             Capital
                              -------             -------           -------          -------           -------             -------
<S>                        <C>               <C>                  <C>              <C>              <C>                 <C>
Capital                    $ 13,878,000      $    13,878,000      $13,878,000      $12,785,000      $    12,785,000     $12,501,000

Adjustments
  General valuation
    allowance                        --                   --          747,000               --                   --         284,000

Goodwill                       (356,000)            (356,000)        (356,000)              --                   --              --

Unrealized gains             (1,453,000)          (1,453,000)      (1,453,000)              --                   --              --

Regulatory capital           12,069,000           12,069,000       12,816,000       12,785,000           12,785,000      12,785,000

Regulatory asset base       156,440,000          156,440,000       75,044,000       94,950,000           94,950,000      57,500,000

Capital ratio                      7.71%                7.71%           17.08%           13.46%               13.46%          22.23%

Minimum required ratio             1.50%                4.00%            8.00%            1.50%                3.00%           8.00%

Capital ratio required
  for "well-capitalized"
  designation                        --                 5.00%           10.00%              --                 5.00%          10.00%
</TABLE>


LIQUIDITY

         Liquidity is a bank's ability to convert assets into cash equivalents
in order to meet daily cash flow requirements, primarily for deposit
withdrawals, loan demand, and maturing liabilities. Without proper management,
First Federal could experience higher costs of obtaining funds due to
insufficient liquidity. On the other hand, excessive liquidity could lead to a
decline in earnings due to the cost of foregoing alternative higher-yielding
investment opportunities.

         Asset liquidity is provided primarily through the repayment and
maturity of investment securities, and the sale and repayment of loans.

         Sources of liability liquidity include customer deposits and
participation in the FHLB advance program. Although deposit growth historically
has been a primary source of liquidity, such balances may be influenced by
changes in the banking industry, interest rates available on other investments,
general economic conditions, competition and other factors. FHLB advances
include both fixed and variable terms and are taken out with varying maturities.
First Federal can borrow an amount equal to 75% of its mortgage loans which are
backed by one-to-four family residential properties. At September 30, 1998,
First Federal had credit available, net of advances drawn down, of approximately
$6 million. First Federal has drawn down such advances in the amount of
approximately $16 million at September 30, 1998, in order to fund dividend
payments to shareholders and to pay various holding company expenses.

         On a consolidated basis, net cash provided by operating activities in
fiscal 1998 was $1,107,023, a $1,282,000 increase from 1997. The $12,947,000 in
net cash provided by investing activities during 1998 consisted primarily of a
$13,855,000 increase in proceeds from calls and maturities of investment
securities held to maturity. Proceeds from sales of investment securities
available for sale increased to $20,206,000 from $541,000 in 1997. The
$7,289,000 in net cash used by financing activities resulted from a decrease of
$3,433,000 in certificates of deposits, coupled with 



                                       47
<PAGE>   49

a net repayment of $4,484,000 in borrowed funds, payment of $496,800 in common
stock dividends, and acquisition of treasury stock in the amount of $669,000.

            First Federal's liquidity ratio at September 30, 1998 was 8.32% and
at September 30, 1997 was 9.28%. Liquidity levels may be increased or decreased
depending upon the yields on investment alternatives, management's expectations
to the level of yield that will be available in the future, and management's
projections as to the short-term demand for funds to be used in loan
origination. First Federal is subject to certain regulatory limitations with
respect to the payment of dividends to SouthFirst. First Federal paid no
dividends to SouthFirst during 1997 or 1996. In 1998, First Federal paid
$2,893,000 to SouthFirst in order to purchase Treasury Stock and partially repay
a revolving line of credit with Regions Bank.

            SouthFirst also requires cash for various purposes including
servicing debt, paying dividends to shareholders and paying general corporate
expenses. The primary source of funds for SouthFirst is dividends from First
Federal. First Federal's capital levels meet the requirements for a "well
capitalized" institution and enable First Federal to pay dividends to
SouthFirst. See "SUPERVISION AND REGULATION -- Regulation of First Federal --
Capital Adequacy Requirements." In addition to dividends, SouthFirst has access
to various capital markets and other sources of borrowings.

            SouthFirst retained $3,624,000 of the net proceeds from the initial
public offering of common stock in 1994. Substantially all of those funds have
been used to pay dividends, (including a special $2.00 per share dividend in
1996), acquire treasury stock, invest in affiliates and pay general corporate
expenses. Accordingly, SouthFirst will likely rely on dividends from First
Federal to repay borrowings under its line of credit, which has been used, in
part, to pay dividends to Shareholders. See " -- Financial Condition --
Short-Term Borrowings."

RESULTS OF OPERATIONS

            NET INCOME

            For the fiscal year ended September 30, 1998, net income increased
$139,375, to $634,874. Earnings per common share was $0.68 for the fiscal year
ended September 30, 1998. The primary increase in net income in fiscal 1998 was
due to an increase of $2,512,000 in interest earned on loans, an increase of
$1,492,000 in interest income on investment securities, an increase of $889,000
in other income, an increase of $2,764,000 in interest expense, and an increase
of $1,897,000 in total other expenses. The large incremental changes in these
areas relative to fiscal 1997 is largely explained by the acquisition of Chilton
County in the first quarter of fiscal 1998.

            For the year ended September 30, 1997, net income increased $512,155
to $495,499 or $0.62 per share. The primary reason for the increase in net
income was due to an increase of approximately $873,000 in interest income on
loans. This increase in interest income on loans was offset, however, by a
decrease of $366,000, in interest income on investments available for sale a
decrease of $189,000 in other income, and an increase of $428,000 in interest
expense for borrowed funds. In addition, for the year ended September 30, 1997,
net income was positively affected by a decrease of $374,000 in compensation and
benefits, which was primarily associated with the $2.00 per share special
dividend and a $430,000 decrease in other expenses, which was incurred in 1996
as a result of the special SAIF assessment in fiscal 1996.


                                       48
<PAGE>   50



            Weighted average shares outstanding in 1998 and 1997 reflects shares
outstanding for the entire year.

            The items discussed in the preceding paragraphs are discussed more
fully below.

            NET INTEREST INCOME

            Net interest income is the difference between the interest First
Federal earns on its loans, investment securities and other earning assets and
the interest cost of its deposits and borrowed funds. This is the primary
component of First Federal's earnings. Net interest income was $4,533,000 for
the twelve months ended September 30, 1998. This increase of $1,241,000 (37.7%)
over the comparable twelve months of 1997 is primarily the result of the effect
the acquisition of Chilton County. The acquisition of Chilton County was largely
responsible for the increase in the average balance of interest earning assets
from $87.6 million to $137.3 million while the average balance of
interest-bearing liabilities increased from $77.6 million to $134.5 million. The
net interest rate spread remained the same as rates on interest-earning assets
decreased two basis points to 8.08%, while cost of funds decreased two basis
points to 4.88%. The combined effect of the increases in average balances and
the changes in rates above resulted in an increase in net interest income.

            Net interest income was $3,292,000 for the twelve months ended
September 30, 1997. This increase of $231,000 (7.5%) over the comparable period
in 1996 was primarily the result of an increase in the net yield on total
interest-earning assets. The net interest rate spread on total interest-earning
assets increased 27 basis points as rates on interest-earning assets increased
18 basis points to 8.10%, while cost of funds decreased 9 basis points to 4.90%
when compared to September 30, 1996.

            Net interest income was $3,061,000 for the twelve months ended
September 30, 1996. This decrease of $43,000 (1.4%) over 1995 resulted primarily
from the increase in interest on deposits and interest on borrowed funds. The
net interest rate spread decreased 25 basis points as rates on interest-earning
assets increased 22 basis points to 7.92%, while cost of funds increased 47
basis points to 4.99% when compared to 1995. The 25 basis point decrease in the
interest rate spread is a result of a small decrease in the yield on loans
during 1996 and an increase on the yield on interest-bearing liabilities offset
by a slight increase in the yield on investments. These changes in yields
resulted from the stabilization of interest rates in the market.

            As previously described above, First Federal's ALCO conducts a gap
analysis in order to assist in analyzing the yields on earning assets and the
rates paid on interest-bearing liabilities. However, there can be no assurance
that such analysis will positively affect earnings. See "-- Capital Resources --
Interest Rate Sensitivity Management" and "Consolidated Average Balances,
Interest Income/Expense and Yields/Rates" tables that appears elsewhere herein.

            RATE/VOLUME VARIANCE ANALYSIS

            The following table sets forth information regarding the extent to
which changes in interest rates, changes in volume of interest assets, and
changes in volume of interest related assets and liabilities have affected First
Federal's interest income and expense during the periods indicated. For each
category of interest-earning asset and interest-bearing liability, information
is provided for changes attributable to (i) changes in volume (change in volume
multiplied by old rate), (ii) changes in rates (change in rate multiplied by old
volume) and (iii) changes in rate/volume (change in rate multiplied by change in

                                       49
<PAGE>   51



volume). Changes in rate/volume have been allocated proportionately between
changes in volume and changes in rates.


<TABLE>
<CAPTION>
                                                                     Year Ended September 30,
                                 ----------------------------------------------------------------------------------------------
                                          1998 vs. 1997                    1997 vs. 1996                     1996 vs. 1995     
                                        Increase (Decrease)              Increase (Decrease)              Increase (Decrease)  
                                        -------------------              -------------------              -------------------
                                             Due to                            Due to                          Due to
                                 ------------------------------     -----------------------------    --------------------------
                                  Volume      Rate       Total      Volume      Rate      Total      Volume     Rate      Total
                                 --------    ------     -------     ------     ------     -----      ------    ------     -----
<S>                              <C>         <C>        <C>         <C>        <C>        <C>        <C>       <C>        <C>

                                                                    (Dollar amounts in thousands)
Interest income:
     Investment securities       $ 1,265       231      $ 1,496      $(417)       15      $(402)     $(306)      128      $(178)
     Loans receivable              2,669      (161)       2,508        825        48        874        666       (71)       595
                                 -------      ----      -------      -----      ----      -----      -----      ----      -----
Total interest income              3,934        69        4,004        408        63        472        360        57        417
                                 =======      ====      =======      =====      ====      =====      =====      ====      =====

Interest expense:
     NOW accounts                    124       (35)          89         (5)      (47)       (52)        (7)       11          4
     Money market demand              (3)        -           (3)         -         5          5         (1)       (1)        (2)
     Passbook savings                117       (40)          78         (3)      (27)       (30)       (39)       18        (21)
     Certificates of deposit
        other than Jumbos          2,404        54        2,458        (37)      (92)      (129)        35       217        252
     Jumbos                           30       (49)         (19)        10        10         20          6         3          9
     Borrowed funds                  122        45          167        423         6        429        229       (11)       218
                                 -------      ----      -------      -----      ----      -----      -----      ----      -----
Total interest expense             2,797       (26)       2,770        387      (145)       242        223       237        460
                                 =======      ====      =======      =====      ====      =====      =====      ====      =====
Change in net interest
     income                        1,137        95        1,234         21       208        230        137      (180)       (43)
                                 =======      ====      =======      =====      ====      =====      =====      ====      =====
</TABLE>


            INTEREST INCOME

            Interest income is a function of the volume of interest earning
assets and their related yields. Interest income was $11,098,000, $7,093,000,
and $6,620,000 for the twelve months ended September 30, 1998, September 30,
1997, and September 30, 1996, respectively. Average interest earning assets
increased $49,735,000 (56.7%) during 1998, and $3,994,000 (4.8%) during 1997,
following an increase of $3,090,000 (3.8%) in 1996. The 1998, 1997 and 1996
yield remained relatively constant, reflecting the relative stability of the
interest rate environment during that period. Interest and fees on loans were
$8,273,000, $5,761,000, and $4,888,000 for the twelve months ended September 30,
1998, September 30, 1997, and September 30, 1996, respectively. Interest and
fees on loans during 1998 increased $2,512,000 (43.6%) compared to 1997.
Interest and fees on loans during fiscal 1997 increased $873,000 (17.9%), as
compared to fiscal 1996. The increase in average loans receivable in 1998 was
largely due to the acquisition of Chilton county plus the strong loan demand in
1998 as a result of lower interest rates. The increase in average loans
receivable during 1997 and 1996, offset somewhat by the small decrease in yields
in loans during 1997 and 1996, resulted in the increase in interest and fees on
loans for 1997 and 1996.

            Interest income on total investment securities, including those held
to maturity and those available for sale, increased $1,493,000 (112.1%) to
$2,825,000 in 1998. The average balance outstanding of investment securities,
including those held to maturity and those available for sale, increased
$17,843,000 (95.1%) to $36,609,000 in 1998 from $18,766,000 in 1997. The yields
on total investment securities were


                                       50
<PAGE>   52



7.72% in 1998 and 7.09% in 1997. The increase in interest income in 1998 was
largely due to the volume of investment securities acquired in connection with
the purchase of Chilton County.

            INTEREST EXPENSE

            Total average interest-bearing liabilities were $134,503,000,
$77,539,000, and $71,396,000 for fiscal years 1998, 1997 and 1996, respectively.
Interest bearing liabilities increased by $56,964,000 (73.5%), $6,143,000
(8.61%), and $2,834,000(4.1%) for 1998, 1997, and 1996, respectively. The rates
paid on these liabilities decreased 2 basis points to 4.88% in 1998, decreased 9
basis points to 4.90% during 1997, and increased 47 basis points to 4.99% in
1996. Total interest expense was $6,565,000 for 1998, $3,801,000 for 1997, and
$3,559,000 for 1996, which represented an increase of $2,764,000 (72.7%),
$242,000 (6.8%) and $266,000 (9.4%) during 1998, 1997 and 1996, respectively.
The increase in 1998 resulted from the additional interest-bearing liabilities
associated with the acquisition of the Chilton County and an increase in the
cost funds. The increase in 1997 resulted from an increase in the cost of funds.
The increase during 1996 resulted from an increase in the rate paid associated
with the general rise in market interest rates and an increase in the average
balance.

            Interest on deposits, the primary component of total interest
expense, increased to $5,416,000 in 1998 from $2,820,000 in 1997. Interest
expense on total deposits for 1996 was $3,006,000. The average balance of
interest bearing deposits increased to $116,692,000 in 1998, primarily as a
result of the Chilton county acquisition. The average volume of outstanding
interest bearing deposits decreased in 1997, but the effect on interest expense
was offset by the increase in rates paid due to market conditions. The average
volume of outstanding interest bearing deposits decreased slightly in 1996 but
the effect on interest expense was offset by the increase in rates paid which
was also due to market conditions.

            Interest expense on borrowed funds, including both short-term and
other borrowed funds, was $1,149,000 and $982,000 for fiscal 1998 and 1997,
respectively. Interest expense on borrowed funds was $553,000 in fiscal 1996.
The increase in 1998 was due to the Chilton County acquisition as well as FHLB
advances to fund loan growth during the year. The increase in 1997 was a result
of additional advances of $7,500,000 from the FHLB to fund First Federal's
continued loan growth. The average balance of FHLB advances outstanding was
$16,379,738 for 1998 and $15,403,351 for 1997. The average balance of borrowed
funds outstanding was $17,810,000 for 1998 and $15,838,000 for 1997.

            PROVISION FOR LOAN LOSSES

            The provision for loan losses is based on management's assessment of
the risk in the loan portfolio, as reflected in the amount of recent loan
losses. The provision for loan losses was $45,000, $36,000, and $1,200 during
1998, 1997, and 1996, respectively. These provisions for loan losses reflect
management's assessment of the quality of the loan portfolio. As previously
discussed, the loan portfolio is comprised primarily of one-to-four family
residential mortgage loans and residential construction loans. The one-to-four
family residential mortgage loans are originated in First Federal's primary
market area of Talladega County, Alabama. Management believes that the credit
risks associated with this type of loan are significantly lower than other loan
types.

            Although residential construction loans have characteristics of
relatively higher credit risks, such as concentrations of amounts due from a
smaller number of borrowers and dependence on the expertise of the builder,
management believes that its residential construction lending policies and
procedures substantially reduce the credit risks associated with this type of
loan. First Federal entered the residential


                                       51
<PAGE>   53


construction lending area in 1994 by purchasing the portfolio of another Alabama
thrift and hiring the loan officer who originated and managed the portfolio. A
significant portion of First Federal's residential construction loans were
originated in Hoover, Alabama, a suburb of Birmingham and one of the most
affluent areas of the state. See "INFORMATION REGARDING SOUTHFIRST -- Business
of First Federal -- General -- Construction Lending." Since acquiring the
portfolio, First Federal has not suffered a significant loss on a residential
construction loan.

            For the reasons discussed above, charge-offs for the total loan
portfolio, net of recoveries, averaged approximately $6,000 from 1994 through
1997. In 1998, net charge-offs increased to $85,000 due primarily to loans
acquired in the Chilton County purchase. Management believes the allowances for
loan losses at September 30, 1998 to be at an adequate level relative to the
total loan portfolio and relative to nonperforming loans.

            Future additions to the allowance may be necessary based on changes
in economic conditions. In addition, various regulatory agencies periodically
review First Federal's allowance for loan losses and may require First Federal
to recognize additions to the allowance based upon an analysis of information
available at the time of their review. See "Management's DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATION -- Allowance for Loan Losses and
Risk Elements."

            OTHER INCOME

            Other income increased $889,000 (80.7%) to $1,990,00 in 1998 from
$1,101,000 in 1997. Other income decreased $189,000 (14.6%) to $1,101,000 in
1997 from $1,290,000 in 1996. The increase in 1998 was largely due to an
increase of $373,000 in employee benefit consulting fees as a result of the
acquisition of Chilton County and Pension & Benefit. The decrease in 1997
resulted primarily from the $583,000 settlement in 1996 of SouthFirst's lawsuit
against USF&G. See "INFORMATION REGARDING SOUTHFIRST -- Business of First
Federal -- Legal Proceedings."

            Service charges and other fees were $712,000, $577,000, and $563,000
in fiscal 1998, 1997, and 1996, respectively. The increase in 1998 was largely
due to additional service charge and fee income derived from the Chilton County
purchase. The fluctuations in 1997 and 1996 were due almost entirely to
increases in income from charges for nonsufficient funds and overdraft charges.

            Gain on sale of loans increased $94,000 (64.8%) in 1998 and $18,000
in 1997. These increases were due to the increased volume of loans sold relative
to prior years. Proceeds from sales of loans increased by $7,113,000 (153.6%) to
$11,743,000 in 1998 and by $125,000 to $14,630,000 in 1997.

            OTHER EXPENSE

            Total other expense was $5,455,000 for 1998, $3,558,000 for 1997 and
$4,274,000 for 1996. The increase in 1998 was $1,897,000 (53.3%) compared to a
decrease in 1997 of $716,000 (16.7%), and an increase of $1,614,000 (60.6%) in
1996.

            Compensation and benefits totaled $3,373,000, $2,095,000, and
$2,469,000 for 1998, 1997, and 1996, respectively. These levels reflect an
increase of $1,278,000 (61.0%) in 1998, a decrease of $374,000 (15.2%) in 1997,
and an increase of $990,000 (66.9%) in 1996. The increase in 1998 was primarily
a result of the increased number of First Federal employees following the
acquisition of Chilton


                                       52
<PAGE>   54


County and Pension & Benefit. The increase in 1998 can also be attributed to
merit and cost-of-living raises and the cost of benefits association with such
increases. The decrease in 1997 was primarily due to additional compensation
awarded to select employees under SouthFirst's two Management Recognition Plans
in 1996 including cash bonuses to SouthFirst's officers of $263,409 and the cost
of a large number of shares released to participants in SouthFirst's Employee
Stock Ownership Plan (the "ESOP") in 1996. The increase in the number of shares
released is attributable to the special $2.00 dividend paid to qualifying
shareholders, including the ESOP, on January 22, 1996. These costs did not recur
in 1997 or 1998.

            Other expenses in 1996 also reflected a special one time SAIF
assessment in the amount of $430,230. This expenditure, in connection with the
federal insurance of accounts, was assessed on an industry wide basis and was
not assessed in prior years. See "SUPERVISION AND REGULATION."

            Other noninterest expense was $695,000, $599,000, and $520,000 for
1998, 1997 and 1996, respectively. These levels correspond to increases of
16.0%, 15.2%, and 40.9% in each of these years. The increase in 1998 was due to
increased costs in other operating expenses as a result of the acquisition of
Chilton County. The decrease in 1997 was primarily due to decreased costs
associated with legal, accounting, and various other operating expenses. The
increase in 1996 was due primarily to increased costs associated with legal and
accounting expenses.

            INCOME TAX EXPENSE

            Income tax expense was $389,000, $303,000, and $92,000 for fiscal
years 1998, 1997, and 1996, respectively. These levels represent an effective
tax rate on pre-tax earnings of 38% for the years ended September 30, 1998 and
September 30, 1997, and a 122% for the year ended September 30, 1996. The
unusually high effective tax rate for the year ended 1996 was due to the
nondeductibility of portions of compensation expense related to SouthFirst's
ESOP and the MRP. For 1998 and 1997, First Federal's effective tax rate was
slightly higher than the statutory rate due to state income taxes and
differences between taxable income for financial reporting and income tax
purposes.

            NEW ACCOUNTING PRONOUNCEMENTS

            In February 1997, the Financial Accounting Standards Board (the
"FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 128,
"Earnings Per Share," which establishes standards for computing and presenting
earnings per share. This new accounting standard applied to entities with
publicly held common stock or potential common stock, such as the Company. SFAS
No. 128 simplifies the standards for computing earnings per share previously
found in other accounting standards, requires dual presentation of basic and
diluted earnings per share on the face of the income statement for entities with
complex capital structures such as the Company, and requires a reconciliation of
the numerator and denominator of the basic earnings per share computation to the
numerator and denominator of the diluted earnings per share computation. The
Company adopted this new accounting standard at December 31, 1997 and restated
all prior period earnings per share data presented.

            In June 1997, the FASB issued SFAS 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.
The comprehensive income and related cumulative equity impact of comprehensive
income items will be required to be disclosed prominently as part of the notes
to the financial statements. Only the impact of unrealized gains or losses on
securities available-for-sale is


                                       53
<PAGE>   55



expected to be disclosed as an additional component of the Company's income
under the requirements of SFAS No. 130. This statement is effective for fiscal
years beginning after December 15, 1997.

            In June 1997, the FASB issued SFAS No. 131, "Disclosures About
Segments of an Enterprise and Related Information," which changes the way public
companies report information about segments of their business on their annual
financial statements and requires them to report selected segment information in
their quarterly reports issued to shareholders. It also requires entity wise
disclosures about the products and service an entity provides, the foreign
countries in which it holds assets and reports revenues, and its major
customers. This statement is effective for fiscal years beginning after December
15, 1997.

            In February 1998, the FASB issued SFAS No. 132, "Employers'
Disclosures about Pensions and Other Postretirement Benefits," which revises
employers' disclosures about pension and other post-retirement benefit plans.
The statement does not change the measurement or recognition of those plans, but
requires additional information on changes in benefits obligations and fair
values of plan assets, and eliminates certain disclosures previously required by
SFAS Nos. 87, 88 and 106. This statement is effective for fiscal years beginning
after December 15, 1997.

ITEM 7.           FINANCIAL STATEMENTS

            The following financial statements are filed with this report:

            Independent Auditors' Report
            Consolidated Statements of Financial Condition as of
                        September 30, 1998 and 1997.
            Consolidated Statements of Operations for the years ended 
                        September 30, 1998, 1997 and 1996.
            Consolidated Statements of Shareholders' Equity for the years 
                        ended September 30, 1998, 1997 and 1996.
            Consolidated Statements of Cash Flows for the years ended 
                        September 30, 1998, 1997 and 1996.
            Notes to Consolidated Financial Statements



                                       54
<PAGE>   56



                           SOUTHFIRST BANCSHARES, INC.

                               SYLACAUGA, ALABAMA

                           SEPTEMBER 30, 1998 AND 1997

--------------------------------------------------------------------------------
                                TABLE OF CONTENTS


<TABLE>
<S>                                                                       <C>
INDEPENDENT AUDITORS' REPORT                                                57

FINANCIAL STATEMENTS:

     Consolidated Statements of Financial Condition                         58

     Consolidated Statements of Operations                               59-60

     Consolidated Statements of Stockholders' Equity                     61-62

     Consolidated Statements of Cash Flows                               63-65

     Notes to Consolidated Financial Statements                          66-90
</TABLE>



                                       55
<PAGE>   57





                          INDEPENDENT AUDITORS' REPORT


November 10, 1998





Board of Directors
SouthFirst Bancshares, Inc.


We have audited the accompanying consolidated statements of financial condition
of SouthFirst Bancshares, Inc. and subsidiaries (the Company) as of September
30, 1998, and the related consolidated statements of operations, stockholders'
equity, and cash flows for the year then ended. These financial statements are
the responsibility of the Company's management. Our responsibility is to express
an opinion on these financial statements based on our audit. The financial
statements of SouthFirst Bancshares, Inc. as of September 30, 1997 and 1996 were
audited by other auditors whose report dated November 21, 1997 expressed an
unqualified opinion on those statements.

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

In our opinion, the 1998 consolidated financial statements referred to above,
present fairly, in all material respects, the financial position of SouthFirst
Bancshares, Inc. and subsidiaries as of September 30, 1998, and the results of
their operations and their cash flows for the year then ended, in conformity
with generally accepted accounting principles.



Jones & Kirkpatrick, P.C.

Certified Public Accountants


                                       56
<PAGE>   58

                          INDEPENDENT AUDITORS' REPORT


The Board of Directors
SouthFirst Bancshares, Inc.:

We have audited the accompanying consolidated statements of financial condition
of SouthFirst Bancshares, Inc. and subsidiary (the Company) as of September 30,
1997 and 1996, and the related consolidated statements of operations,
stockholders' equity, and cash flows for each of the years in the three-year 
period ended September 30, 1997. These financial statements are the 
responsibility of the Company's management. Our responsibility is to express an 
opinion on these financial statements based on our audits.

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

In our opinion, the consolidated financial statements referred to above, 
present fairly, in all material respects, the financial position of SouthFirst 
Bancshares, Inc. and subsidiary as of September 30, 1997 and 1996, and the 
results of their operations and their cash flows for each of the years in the 
three-year period ended September 30, 1997, in conformity with generally 
accepted accounting principles.


                                        KPMG Peat Marwick LLP

Birmingham, Alabama
November 21, 1997


                                       57
<PAGE>   59
                                                                              58

                           SOUTHFIRST BANCSHARES, INC.
                                AND SUBSIDIARIES

                 Consolidated Statements of Financial Condition
                           September 30, 1998 and 1997


-------------------------------------------------------------------------------
<TABLE>
<CAPTION>
                                     ASSETS
                                     ------
                                                                                  1998                 1997
                                                                                  ----                 ----
<S>                                                                           <C>                 <C>         
Cash and amounts due from depository institutions                             $   9,213,906       $  2,448,123
Investment securities held to maturity, at cost                                     971,106            162,448
Investment securities available for sale, at fair value                          36,823,772         16,665,770
Loans receivable, net of allowance for loan losses of
  $732,021 in 1998 and $284,324 in 1997                                         104,590,192         71,682,255
Loans held for sale at cost (which approximates fair value)                          92,750            333,750
Premises and equipment, net                                                       3,903,308          1,780,286
Accrued interest receivable                                                       1,044,978            529,500
Investments in affiliates                                                           144,617            192,560
Other assets                                                                      1,733,463          1,994,010
                                                                              -------------       ------------

    Total Assets                                                              $ 158,518,092       $ 95,788,702
                                                                              =============       ============

                      LIABILITIES AND STOCKHOLDERS' EQUITY
                      ------------------------------------

                                                                                  1998                 1997
                                                                                  ----                 ----
Liabilities:
    Deposits:
      Non-interest bearing                                                    $   3,435,519       $  1,255,745
      Interest bearing                                                          120,448,157         59,296,791
                                                                              -------------       ------------
        Total deposits                                                          123,883,676         60,552,536
     Advances by borrowers for property taxes and insurance                         327,126            388,918
     Accrued interest payable                                                     1,071,183            859,111
     Borrowed funds                                                              16,169,068         18,653,386
     Accrued expenses and other liabilities                                       1,396,424          1,711,417
                                                                              -------------       ------------
        Total liabilities                                                       142,847,477         82,165,368
                                                                              -------------       ------------

Stockholders' equity:
  Common stock, $.01 par value, 2,000,000 shares authorized;
    999,643 shares issued and 914,432 shares outstanding in 1998;
    863,200 shares issued and 812,799 shares outstanding in 1997                      9,996              8,632
  Additional paid-in capital                                                      9,810,963          7,792,748
  Treasury stock, at cost (54,410 shares in 1998; 15,600 shares in 1997)           (867,087)          (198,392)
  Deferred compensation on common stock employee benefit plans                     (778,508)          (914,604)
  Retained earnings, substantially restricted                                     5,953,346          5,815,352
  Unrealized gain on investment securities available-for-sale, net of tax         1,541,905          1,119,598
                                                                              -------------       ------------
      Total stockholders' equity                                                 15,670,615         13,623,334
                                                                              -------------       ------------

  Commitments and contingencies (Note 14)                                                 -                  -
                                                                              -------------       ------------

  Total liabilities and stockholders' equity                                  $ 158,518,092       $ 95,788,702
                                                                              =============       ============
</TABLE>


See accompanying notes to consolidated financial statements.


<PAGE>   60
                                                                              59

                           SOUTHFIRST BANCSHARES, INC.
                                AND SUBSIDIARIES

                      Consolidated Statements of Operations
                  Years Ended September 30, 1998, 1997 and 1996

-------------------------------------------------------------------------------
<TABLE>
<CAPTION>

                                                                1998            1997            1996
                                                                ----            ----            ----

<S>                                                        <C>              <C>             <C>        
Interest and dividend income:
  Interest and fees on loans                               $  8,272,834     $ 5,761,018     $ 4,888,183
  Interest and dividend income on investment securities       2,825,283       1,332,378       1,732,093
                                                           ------------     -----------     -----------

      Total interest and dividend income                     11,098,117       7,093,396       6,620,276
                                                           ------------     -----------     -----------

Interest expense:
  Interest on deposits                                        5,416,128       2,819,560       3,006,037
  Interest on borrowed funds                                  1,148,782         981,737         553,372
                                                           ------------     -----------     -----------
      Total interest expense                                  6,564,910       3,801,297       3,559,409
                                                           ------------     -----------     -----------

      Net interest income                                     4,533,207       3,292,099       3,060,867

Provision for loan losses                                        44,744          36,465           1,200
                                                           ------------     -----------     -----------

  Net interest income after provision for loan losses         4,488,463       3,255,634       3,059,667
                                                           ------------     -----------     -----------

Other income:
  Service charges and other fees                                711,603         577,344         563,235
  Employee benefit consulting fees                              758,835         386,090               -
  Gain on sale of loans                                         238,907         144,621         127,386
  Gain on sale of foreclosed real estate                              -               -          10,233
  Gain on sales and calls of investment
     securities available-for-sale                              123,736          15,705          21,203
  Gain (loss) on sale of premises and equipment                   2,565               -          (7,543)
  Equity in net loss of affiliates                              (26,279)        (61,977)        (66,773)
  Other                                                         180,581          39,305         642,259
                                                           ------------     -----------     -----------

      Total other income                                      1,989,948       1,101,088       1,290,000
                                                           ------------     -----------     -----------
</TABLE>


                                  (Continued)





See accompanying notes to consolidated financial statements.
<PAGE>   61
                                                                              60

                           SOUTHFIRST BANCSHARES, INC.
                                AND SUBSIDIARIES

                Consolidated Statements of Operations (Continued)
                  Years Ended September 30, 1998, 1997 and 1996
-------------------------------------------------------------------------------

<TABLE>
<CAPTION>
                                              1998         1997          1996
                                              ----         ----          ----

<S>                                       <C>          <C>          <C>        
Other expenses:
   Compensation and benefits              $3,373,157   $2,094,824   $ 2,468,570
   Net occupancy expense                     282,015      204,682       154,208
   Furniture and fixtures                    331,505      226,515       168,600
   Data processing                           293,820      176,780       171,692
   Office supplies and expenses              359,713      196,700       185,953
   Deposit insurance premiums                119,330       59,617       175,542
   Special SAIF assessment                         -            -       430,230
   Other                                     695,368      599,040       519,606
                                          ----------   ----------   -----------

      Total other expenses                 5,454,908    3,558,158     4,274,401
                                          ----------   ----------   -----------

Income before income taxes                 1,023,503      798,564        75,266

Income tax expense                           388,629      303,065        91,922
                                          ----------   ----------   -----------

   Net income (loss)                      $  634,874   $  495,499   $   (16,656)
                                          ==========   ==========   =========== 



Primary earnings (loss) per share         $     0.68   $     0.62   $     (0.02)

Fully diluted earnings (loss) per share   $     0.67   $     0.62   $     (0.02)

Weighted average shares outstanding:
   Primary                                   931,195      795,479       810,997
   Fully diluted                             950,833      797,722       810,997
</TABLE>










See accompanying notes to consolidated financial statements.

<PAGE>   62
                                                                              61
                           SOUTHFIRST BANCSHARES, INC.
                                AND SUBSIDIARIES

                 Consolidated Statements of Stockholders' Equity
                  Years Ended September 30, 1998, 1997 and 1996
--------------------------------------------------------------------------------
<TABLE>
<CAPTION>

                                                                                                               Net
                                                                                 Deferred                 unrealized
                                                                               compensation                 holding
                                                                  Retained      on common                   gain on
                                                  Additional     earnings-        stock                   available-       Total
                                         Common    paid-in     substantially     employee      Treasury    for-sale    stockholders'
                                          stock    capital       restricted   benefit plans      stock    securities      equity
                                          -----    -------       ----------   -------------      -----    ----------      ------
                                        
<S>                                      <C>      <C>          <C>            <C>            <C>          <C>         <C>         
Balance - September 30, 1995              $8,300  $7,240,066    $ 7,624,515    $(597,600)    $       -    $495,305    $ 14,770,586

Net loss 1996                                  -           -        (16,656)           -             -           -         (16,656)

Release of unallocated ESOP shares             -      41,822              -      167,290             -           -         209,112

Issuance of common stock -
   Management Recognition Plans              332     422,968              -     (423,300)            -           -               -

Vesting of shares on Management
   Recognition Plans                           -           -              -      108,900             -           -         108,900

Acquisition of Treasury stock                  -           -              -            -      (500,802)          -        (500,802)

Cash dividends declared ($2.50/share)          -           -     (1,917,558)           -             -           -      (1,917,558)

Increase in unrealized holding gain on
   available-for-sale securities               -           -              -            -             -     234,232         234,232
                                          ------  ----------    -----------    ---------     --------     --------    ------------

Balance - September 30, 1996               8,632   7,704,856      5,690,301     (744,710)     (500,802)    729,537      12,887,814

Net income 1997                                -           -        495,499            -             -           -         495,499

Release of unallocated ESOP shares             -      34,129              -       77,391             -           -         111,520

Acquisition of ESOP shares                     -           -              -      (16,806)            -           -         (16,806)

Vesting of shares on Management
   Recognition Plans                           -      26,354              -       59,760             -           -          86,114

Issuance of deferred compensation shares       -      27,409              -     (298,532)      271,123           -               0

Vesting of deferred compensation shares        -           -              -        8,293             -           -           8,293

Acquisition of Treasury stock                  -           -              -            -       (34,606)          -         (34,606)

Sale of Treasury shares                        -           -              -            -        65,893           -          65,893
</TABLE>


                                  (Continued)




See accompanying notes to consolidated financial statements.

<PAGE>   63

                                                                              62

                           SOUTHFIRST BANCSHARES, INC.
                                AND SUBSIDIARIES

           Consolidated Statements of Stockholders' Equity (Continued)
                  Years Ended September 30, 1998, 1997 and 1996
--------------------------------------------------------------------------------
<TABLE>
<CAPTION>


                                                                                                           Net
                                                                              Deferred                  unrealized
                                                                             compensation                 holding
                                                                 Retained      on common                   gain on
                                                  Additional     earnings-      stock                    available-      Total
                                          Common    paid-in    substantially   employee      Treasury     for-sale    stockholders'
                                          stock     capital      restricted  benefit plans    stock      securities       equity
                                          -----     -------      ----------  -------------    -----      ----------       ------

<S>                                      <C>      <C>          <C>            <C>          <C>          <C>          <C>          
Cash dividends declared ($.50/share)      $    -   $        -   $  (370,448)   $       -    $       -    $        -   $   (370,448)

Increase in unrealized holding gain on
 available-for-sale securities                 -            -             -            -            -       390,061        390,061
                                          ------   ----------   -----------    ---------    ---------    ----------   ------------

Balance - September 30, 1997               8,632    7,792,748     5,815,352     (914,604)    (198,392)    1,119,598     13,623,334

Net income 1998                                -            -       634,874            -            -             -        634,874

Release of unallocated ESOP shares             -       37,600             -       40,000            -             -         77,600

Vesting of shares on Management
 Recognition Plans                             -       39,740             -       76,194            -             -        115,934

Vesting of deferred compensation shares        -            -             -       19,902            -             -         19,902

Acquisition of Treasury stock                  -            -             -            -     (668,695)            -       (668,695)

Issuance of common stock                   1,364    1,940,875             -            -            -             -      1,942,239

Increase in unrealized holding gain on
 available-for-sale securities                 -            -             -            -            -       422,307        422,307

Cash dividends declared ($.575/share)          -            -      (496,880)           -            -             -       (496,880)
                                          ------   ----------   -----------    ---------    ---------    ----------   ------------

Balance - September 30, 1998              $9,996   $9,810,963   $ 5,953,346    $(778,508)   $(867,087)   $1,541,905   $ 15,670,615
                                          ======   ==========   ===========    =========    =========    ==========   ============
</TABLE>










See accompanying notes to consolidated financial statements.



<PAGE>   64
                                                                              63

                           SOUTHFIRST BANCSHARES, INC.
                                AND SUBSIDIARIES

                      Consolidated Statements of Cash Flows
                  Years Ended September 30, 1998, 1997 and 1996
--------------------------------------------------------------------------------
<TABLE>
<CAPTION>

                                                                   1998            1997            1996
                                                                   ----            ----            ----

<S>                                                           <C>              <C>             <C>         
OPERATING ACTIVITIES
Net income (loss)                                             $    634,874     $   495,499     $   (16,656)

Adjustments to reconcile net income (loss) to net cash
provided by operating activities:
  Provision for loan losses                                         44,744          36,465           1,200
  Depreciation and amortization                                    345,844         170,896         137,545
  Equity in loss of unconsolidated affiliates                       26,279          61,977          66,773
  Proceeds from sales of loans                                  11,743,414       4,629,621       4,359,996
  Loans originated for sale                                    (11,263,507)     (4,687,650)     (4,490,996)
  Gain on sale of loans                                           (238,907)       (144,621)       (127,386)
  (Gain) loss on sale of premises and equipment                     (2,565)              -           7,543
  Increase in deferred loan origination fees                             -               -          18,012
  Compensation expense on ESOP and MRPs                            213,436         205,927         318,012
  Gain on sale of investment securities available-for-sale        (123,736)        (15,705)        (21,203)
  Net amortization of premium on investment securities             (73,995)          1,683          11,015
  Gain on sale of foreclosed real estate                                 -               -         (10,233)
  (Increase) decrease in accrued interest receivable                26,377          24,106         (20,087)
  (Increase) decrease in other assets                              794,629      (1,358,108)       (221,022)
  Increase (decrease) in accrued interest payable                  (41,500)         16,826          18,400
  Increase (decrease) in accrued expenses
   and other liabilities                                          (977,764)        388,866         363,206
                                                              ------------     -----------     ----------- 

   Net cash provided (used) by operating activities              1,107,623        (174,218)        394,119
                                                              ------------     -----------     ----------- 

INVESTING ACTIVITIES

Net cash paid for acquisition                                     (536,430)              -               -
Investment in affiliated companies                                 (75,000)        (70,000)       (175,000)
Proceeds from calls and maturities of investment
   securities held-to-maturity                                  13,855,491         153,853       1,039,115
Proceeds from calls and maturities of investment
   securities available-for-sale                                   100,281       8,706,873       7,335,328
Proceeds from sales of investment securities
   available-for-sale                                           20,206,296         541,176               -
</TABLE>

                                  (Continued)

See accompanying notes to consolidated financial statements.


<PAGE>   65
                                                                              64

                           SOUTHFIRST BANCSHARES, INC.
                                AND SUBSIDIARIES

                Consolidated Statements of Cash Flows (Continued)
                  Years Ended September 30, 1998, 1997 and 1996

--------------------------------------------------------------------------------
<TABLE>
<CAPTION>
                                                            1998            1997              1996
                                                            ----            ----              ----

<S>                                                     <C>              <C>              <C>         
INVESTING ACTIVITIES (Continued)
-------------------

Purchase of investment securities held-to-maturity      $          -     $   (162,448)    $  (403,853)
Purchase of investment securities available-for-sale     (18,813,395)      (3,500,000)     (4,540,770)
Net increase in loans                                       (936,336)      (9,316,679)     (8,761,092)
Proceeds from sale of premises and equipment                  11,106                -          28,835
Purchase of premises and equipment                          (864,793)        (148,700)       (519,732)
Proceeds from sale of foreclosed real estate                       -                -          39,119
                                                        ------------     ------------     -----------

   Net cash provided (used) by investing activities       12,947,220       (3,795,925)     (5,958,050)
                                                        ------------     ------------     -----------

FINANCING ACTIVITIES
--------------------

Net increase (decrease) in demand accounts
   and savings accounts                                    1,790,205       (1,436,968)       (813,552)
Net increase (decrease) in certificates of deposit        (3,433,339)      (2,105,099)      2,075,997
Proceeds from borrowed funds                              10,629,505       39,315,658       7,267,811
Repayment of borrowed funds                              (15,113,823)     (31,621,557)     (2,378,378)
Net proceeds from issuance of common stock                   116,200           65,893               -
Cash dividends paid                                         (496,880)        (370,448)     (1,917,558)
Acquisition of employee stock ownership plan shares                -          (16,806)              -
Acquisition of treasury stock                               (668,695)         (34,606)       (500,802)
Decrease in advances by borrowers
  for property taxes and insurance                          (112,233)          (3,362)         (8,125)
                                                        ------------     ------------     -----------

   Net cash provided (used) by financing activities       (7,289,060)       3,792,705       3,725,393
                                                        ------------     ------------     -----------

Increase (decrease) in cash and amounts due from
  depository institutions                                  6,765,783         (177,438)     (1,838,538)

Cash and amounts due from depository institutions
  at beginning of year                                     2,448,123        2,625,561       4,464,099
                                                        ------------     ------------     -----------

Cash and amounts due from depository institutions
  at end of year                                        $  9,213,906     $  2,448,123     $ 2,625,561
                                                        ============     ============     ===========
</TABLE>


                                  (Continued)



See accompanying notes to consolidated financial statements.

<PAGE>   66
                                                                              65

                           SOUTHFIRST BANCSHARES, INC.
                                AND SUBSIDIARIES

                Consolidated Statements of Cash Flows (Continued)
                  Years Ended September 30, 1998, 1997 and 1996
--------------------------------------------------------------------------------
<TABLE>
<CAPTION>

                                                                             1998          1997          1996
                                                                             ----          ----          ----

<S>                                                                      <C>            <C>           <C>       
Supplemental information on cash payments:
------------------------------------------
  Interest paid                                                          $ 6,352,838    $3,784,471    $3,541,009
                                                                         ===========    ==========    ==========

  Income taxes paid                                                      $   426,888    $   93,575    $  344,757
                                                                         ===========    ==========    ==========

Supplemental information on non-cash transactions:
--------------------------------------------------
  Change in net unrealized gain on investment
    securities available-for-sale                                        $   681,154    $  606,945    $  400,536
                                                                         ===========    ==========    ==========

  Disposition of investment in affiliate by issuance of loan             $    96,664    $        -    $        -
                                                                         ===========    ==========    ==========

  Acquisition of company through business combination accounted for as purchase:
    Assets acquired:
      Cash and amounts due from depository institutions                  $ 2,787,484
      Investment securities                                               35,436,448
      Loans receivable, net                                               31,919,681
      Premises and equipment                                               1,558,213
      Accrued interest receivable                                            541,855
      Other assets                                                           215,684
                                                                         -----------
        Total assets                                                      72,459,365
                                                                         -----------

    Liabilities assumed:
      Deposits                                                            64,974,274
      Advances by borrowers for property taxes and insurance                  50,441
      Accrued interest payable                                               253,572
      Borrowed funds                                                       2,000,000
      Accrued expenses and other liabilities                                 403,924
                                                                         -----------
        Total liabilities                                                 67,682,211
                                                                         -----------

      Net assets acquired                                                  4,777,154
                                                                         -----------

      Consideration paid:
        Cash                                                               3,323,914
        Common stock                                                       1,826,039
                                                                         -----------
          Total paid                                                       5,149,953
                                                                         -----------

      Goodwill recorded                                                  $   372,799
                                                                         ===========
</TABLE>








See accompanying notes to consolidated financial statements.
<PAGE>   67
                                                                              66

                           SOUTHFIRST BANCSHARES, INC.
                                AND SUBSIDIARIES

                   Notes To Consolidated Financial Statements

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

1.   SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

     Organization - The accompanying consolidated financial statements include
     the accounts of SouthFirst Bancshares, Inc. (the Corporation) and its
     wholly-owned subsidiaries, First Federal of the South (the Bank, formerly
     First Federal Savings & Loan Association of Sylacauga) and Pension &
     Benefit Financial Services, Inc. (an employee benefit consulting company),
     collectively as the Company. All significant intercompany accounts and
     transactions have been eliminated in consolidation.

     On February 13, 1995, the Bank was converted from a mutual to stock form of
     ownership (the Conversion) whereupon the Corporation, approved by the OTS
     as a thrift holding company, acquired all of the issued and outstanding
     shares of the Bank. The Corporation, simultaneously with the Conversion,
     issued 830,000 shares in the initial public offering of its common stock,
     par value $.01 per share, at $10.00 per share, for a gross offering
     proceeds of $8,300,000. The net offering proceeds to the Corporation, after
     deduction of all expenses and fees associated with the offering, was
     $7,248,366. Fifty percent (50%) of the net proceeds, or $3,624,183, was
     distributed to the Bank, as additional capital, in exchange for all of the
     issued and outstanding shares of capital stock of the Bank. The Corporation
     also loaned $664,000 of the net offering proceeds to the trustee of the
     SouthFirst Bancshares, Inc., Employee Stock Ownership Plan (the ESOP), who
     purchased, on behalf of the trust for the ESOP, 66,400 shares (or 8%) of
     the shares sold by the Corporation in the public offering. The loan will be
     repaid from contributions made by the Bank pursuant to the ESOP; and, as
     the loan is repaid, shares will be released to the accounts of the
     employees eligible to participate therein.

     The Bank, pursuant to applicable OTS regulations, established a special
     "liquidation account" for the benefit of the eligible account holders and
     supplemental eligible account holders in the Conversion. The liquidation
     account was established in an amount equal to the regulatory capital of the
     Bank as of the date of the statement of financial condition contained in
     the final Prospectus. Each eligible account holder and supplemental
     eligible account holder is entitled, on a complete liquidation of the Bank
     after the Conversion (and only in such event), to an interest in the
     liquidation account. The initial interest in such liquidation account is
     determined by multiplying the opening balance in the liquidation account by
     a fraction of which the numerator is the amount of the qualifying deposit
     in the related deposit account and the denominator is the total amount of
     the qualifying deposits of all eligible account holders and supplemental
     eligible account holders in the Bank. If, on any annual closing date
     subsequent to the Conversion, the amount in any qualifying deposit account
     is less than the amount in such account on the initial applicable date,
     then the interest in the liquidation account is reduced by an amount
     proportionate to any such reduction. If, subsequent to the Conversion, a
     qualified deposit account is closed, then the interest of the account
     holder in the liquidation account will be reduced to zero. A merger,
     consolidation, sale of bulk assets or similar combination or transaction
     with an FDIC insured institution, in which the Bank is not the


                                   (Continued)


<PAGE>   68

                                                                              67

                           SOUTHFIRST BANCSHARES, INC.
                                AND SUBSIDIARIES

             Notes to Consolidated Financial Statements (Continued)

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

1.   SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

     surviving insured institution, would not be considered to be a
     "liquidation" under which any distribution of the liquidation account would
     be made. In such a transaction, the liquidation account would be assumed by
     the surviving institution. The creation and maintenance of the liquidation
     account would not restrict the use or application of any of the capital
     accounts of the Bank, except that the Bank may not declare or pay a cash
     dividend to, or repurchase any of its capital stock from, the Corporation,
     if the effect of such dividend or repurchase would be to cause its equity
     to be reduced below the aggregate amount then required for the liquidation
     account.

     The Company provides a full range of banking services to individual and
     corporate customers in its primary market area of the cities of Sylacauga,
     Clanton, Talladega and Centreville in the state of Alabama, and provides
     lending services in Birmingham, Rainbow City and Dothan, Alabama. The
     Company is subject to competition from other financial institutions. The
     Company is subject to the regulations of certain federal agencies and
     undergoes periodic examinations by those regulatory authorities.

     The accounting principles and reporting policies of the Company, and the
     methods of applying these principles, conform with generally accepted
     accounting principles and with general practice within the savings and loan
     industry. In preparing the financial statements, management is required to
     make estimates and assumptions that affect the reported amounts of assets
     and liabilities as of the date of the balance sheet and revenues and
     expenses for the period. Actual results could differ significantly from
     those estimates.

     Material estimates that are particularly susceptible to significant change
     in the near-term relate to the determination of the allowance for loan
     losses. In connection with the determination of the allowance for loan
     losses, management obtains independent appraisals for properties
     collateralizing significant troubled loans.

     A substantial portion of the Company's loans are secured by real estate in
     the Company's primary market area. Accordingly, the ultimate collectibility
     of a substantial portion of the Company's loan portfolio is susceptible to
     changes in market conditions in the Company's primary market area.

     The Bank began construction lending activities in March of 1994. As of
     September 30, 1998, the Bank has not experienced significant loss on the
     construction loan portfolio. Since these lending activities are fairly new
     to the Bank, the Bank does not have the same historical data available for
     construction loans as for other loans. As of September 30, 1998, seven
     borrowers had construction loan commitments in excess of $500,000 with the
     largest


                                   (Continued)


<PAGE>   69

                                                                              68

                           SOUTHFIRST BANCSHARES, INC.
                                AND SUBSIDIARIES

             Notes to Consolidated Financial Statements (Continued)

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

1.   SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

     commitment being $2,079,044. Due to this concentration of loans, a default
     by certain construction loan borrowers or other financial difficulty could
     result in a significant addition to the allowance for loan losses.

     Management believes that the allowances for losses on loans and foreclosed
     real estate are adequate. While management uses available information to
     recognize losses on loans and foreclosed real estate, future additions to
     the allowances may be necessary based on changes in economic conditions,
     particularly in the Company's primary market area. In addition, various
     regulatory agencies, as an integral part of their examination process,
     periodically review the Company's allowances for loan losses and foreclosed
     real estate. Such agencies may require the Company to recognize additions
     to the allowances based on their judgments about information available to
     them at the time of their examination.

     The principles which significantly affect the determination of financial
     position, results of operations and cash flows are summarized below.

     Investment Securities - The Company classifies its investments in one of
     the following three categories: (i) held-to-maturity securities, (ii)
     securities available for sale, and (iii) trading account securities.
     Investment securities held to maturity represent securities which
     management has the intent and ability to hold to maturity. These securities
     are reported at cost adjusted for amortization of premiums and accretion of
     discounts using the interest method. Investment securities available for
     sale represent securities which management may decide to sell prior to
     maturity for liquidity, tax planning or other valid business purposes.
     Available-for-sale securities are reported at fair value with any
     unrealized gains or losses excluded from earnings and reflected as a net
     amount in a separate component of stockholders' equity until realized.
     Trading account securities represent securities which management has
     purchased and is holding principally for the purpose of selling in the near
     term. Trading account securities are reported at fair value with any
     unrealized gains or losses included in earnings.

     Declines in fair value of investment securities (available for sale or held
     to maturity) that are considered other than temporary are charged to
     securities losses, reducing the carrying value of such securities. Gains or
     losses on the sale of investment securities are computed using the specific
     identification method and are shown separately in non-interest income in
     the consolidated statements of operations. No securities were classified as
     trading account securities as of September 30, 1998 or 1997.


                                   (Continued)


<PAGE>   70

                                                                              69

                           SOUTHFIRST BANCSHARES, INC.
                                AND SUBSIDIARIES

             Notes to Consolidated Financial Statements (Continued)

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

1.   SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

     During the period from November 15, 1995 to December 31, 1995, the
     Financial Accounting Standards Board allowed companies to reassess the
     appropriateness of the classifications of all securities held at that time
     and account for any resulting reclassifications at fair value.
     Reclassifications from the held-to-maturity category that result from this
     one-time reassessment do not call into question the intent of an entity to
     hold other debt securities to maturity in the future. The Company
     transferred, effective December 31, 1995, all of its collateralized
     mortgage obligations with a total amortized cost of $12,476,980 and fair
     value of $12,551,775 to the classification of available for sale. The
     unrealized net holding gains on the collateralized mortgage obligations at
     December 31, 1995 totaled approximately $75,000 and were included as a
     separate component of stockholders' equity, net of income taxes of
     approximately $28,000.

     The stock of the Federal Home Loan Bank has no quoted fair value and no
     ready market exists. The investment in the stock is required of insured
     institutions that utilize the services of the Federal Home Loan Bank. The
     Federal Home Loan Bank will purchase the stock at its cost basis from the
     Company in the event the Company ceases to utilize the services of the
     Federal Home Loan Bank.

     Cash Equivalents - For purposes of presentation in the consolidated
     statements of cash flows, cash and cash equivalents are defined as those
     amounts included in the statement of financial condition caption "cash and
     amounts due from depository institutions".

     Premises and Equipment - Land is stated at cost. Premises and equipment are
     carried at cost less accumulated depreciation. Depreciation is provided by
     the straight-line method at rates intended to distribute the cost of
     buildings and improvements and furniture, fixtures, and equipment over
     their estimated service lives of 40 years and 3 to 12 years, respectively.

     Foreclosed Real Estate - For real estate acquired through foreclosure, a
     new cost basis is established at fair value at the time of foreclosure
     through a charge to the allowance for loan losses with a valuation
     allowance established for estimated costs to sell. The charge to establish
     the valuation allowance is reflected in other expenses. Fair value for
     significant properties is determined through outside appraisal of the
     collateral. Subsequent to foreclosure, foreclosed assets are carried at the
     lower of fair value less estimated costs to sell or cost, with the
     difference recorded as a valuation allowance on an individual asset basis.
     Subsequent decreases in fair value and increases in fair value, up to the
     value established at foreclosure, are recognized as charges or credits to
     expense.


                                   (Continued)



<PAGE>   71

                                                                              70

                           SOUTHFIRST BANCSHARES, INC.
                                AND SUBSIDIARIES

             Notes to Consolidated Financial Statements (Continued)

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

1.   SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

     Loans Receivable, Loans Held for Sale and Interest Income - Loans
     receivable are stated at principal amounts outstanding less the undisbursed
     portion of loans, unearned interest income, deferred loan fees, and the
     allowance for loan losses. Interest income on loans is credited to income
     based on the principal amount outstanding at the respective rate of
     interest except for add on installment loans for which interest is
     recognized on a method approximating the interest method. It is the general
     policy of the Company to discontinue the accrual of interest when principal
     or interest payments are delinquent and the ultimate collection of either
     is in doubt.

     Loans held for sale are carried at the lower of cost or market, determined
     on an aggregate basis.

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

     Loan Origination Fees, Premiums and Discounts on Loans, Mortgage-Backed
     Securities and Collateralized Mortgage Obligations - Loan origination fees
     and certain direct loan origination costs are deferred and recognized over
     the lives of the related loans as an adjustment of the loan yields using
     the interest method.

     Premiums or discounts on loans, mortgage-backed securities, and
     collateralized mortgage obligations are amortized over the estimated lives
     of the related mortgage loans, adjusted for prepayments, using a method
     approximating the interest method. Premiums and discounts on loans,
     mortgage-backed securities, and collateralized mortgage obligations were
     insignificant at September 30, 1998.

     Income Taxes - The Company provides for income taxes based upon pretax
     income, adjusted for permanent differences between reported and taxable
     earnings. Deferred tax assets and liabilities are recognized for the future
     tax consequences attributable to differences between the financial
     statement carrying amounts of existing assets and liabilities and their
     respective tax basis. Deferred tax assets and liabilities are measured
     using enacted tax rates expected to apply to taxable income in the years in
     which those temporary differences are expected to be realized or settled.
     The effect on deferred tax assets and liabilities of a change in tax rates
     is recognized in the period that includes the enactment date.


                                   (Continued)


<PAGE>   72

                                                                              71

                           SOUTHFIRST BANCSHARES, INC.
                                AND SUBSIDIARIES

             Notes to Consolidated Financial Statements (Continued)

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

1.   SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

     Loan Sales - Gains or losses on loan sales are recognized at the time of
     sale and are determined by the difference between net sales proceeds and
     the carrying value of the loans sold.

     Advertising - Advertising costs are charged to operations when incurred.
     Advertising expense was $51,150, $29,267 and $26,895 for the years ended
     September 30, 1998, 1997 and 1996, respectively.

     Earnings per Share - Primary earnings per share of common stock has been
     computed on the basis of the weighted-average number of shares of common
     stock outstanding. Fully diluted earnings per share reflects the potential
     dilution that could occur if the Company's outstanding options to acquire
     common stock were exercised. The exercise of these options accounts for the
     differences between primary and diluted weighted average shares
     outstanding. Options on 67,511 shares in 1998 and 78,850 shares in 1996 of
     common stock were not included in computed diluted earnings per share
     because their effects were antidilutive.

     Reclassification - Certain amounts in the financial statements presented
     have been reclassified from amounts previously reported in order to be
     comparable between years. These reclassifications have no effect on
     previously reported stockholders' equity or net income during the periods
     involved.


2.   INVESTMENT SECURITIES

     Debt and equity securities have been classified in the consolidated
     statements of financial condition according to management's intent. The
     carrying amount of securities and their approximate fair value at September
     30 were as follows:


                                   (Continued)


<PAGE>   73

                                                                              72

                           SOUTHFIRST BANCSHARES, INC.
                                AND SUBSIDIARIES

             Notes to Consolidated Financial Statements (Continued)

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

2.   INVESTMENT SECURITIES (Continued)

<TABLE>
<CAPTION>
                                                                          Gross          Gross
                                                       Amortized       Unrealized      Unrealized
     Held-to-Maturity Securities                          Cost            Gains          Losses          Fair Value
     ---------------------------                          ----            -----          ------          ----------
     <S>                                              <C>              <C>             <C>              <C>
     September 30, 1998:
        U.S. Government and
           agency securities                          $   499,385      $      290      $        0     $    499,675
        Mortgage-backed securities                         90,205             759               0           90,964
        Other securities                                  381,516               0               0          381,516
                                                      -----------      ----------      ----------     ------------
                                                      $   971,106      $    1,049      $        0     $    972,155
                                                      ===========      ==========      ==========     ============

     September 30, 1997:
        Other securities                              $   162,448      $        0      $        0     $    162,448
                                                      ===========      ==========      ==========     ============

     Available-for-Sale Securities

     September 30, 1998:
        FHLB agency notes                             $ 1,078,128      $   22,533      $        0     $  1,100,661
        Investment in FHLB stock                        1,375,400               0               0        1,375,400
        FHLMC stock                                        43,005       2,136,525               0        2,179,530
        Other common stock                                570,385         143,053               0          713,438
        Collateral mortgage
           obligations (CMO's)                          4,325,101           8,275           2,057        4,331,319
        AMF mutual fund                                   585,502               0               0          585,502
        Mortgage-backed securities                     26,359,313         210,453          31,844       26,537,922
                                                      -----------      ----------      ----------     ------------
                                                      $34,336,834      $2,520,839      $   33,901     $ 36,823,772
                                                      ===========      ==========      ==========     ============

     September 30, 1997:
        FHLB agency notes                             $ 1,994,524      $   13,277      $        0     $  2,007,801
        Investment in FHLB stock                          853,000               0               0          853,000
        FHLMC stock                                        43,005       1,482,967               0        1,525,972
        Other common stock                                585,385         245,240               0          830,625
        Collateral mortgage
            obligations (CMO's)                         6,217,005          32,004         108,247        6,140,762
        AMF mutual fund                                   556,191               0               0          556,191
        Mortgage-backed securities                      4,610,874         145,055           4,510        4,751,419
                                                      -----------      ----------      ----------     ------------
                                                      $14,859,984      $1,918,543      $  112,757     $ 16,665,770
                                                      ===========      ==========      ==========     ============
</TABLE>


                                   (Continued)


<PAGE>   74

                                                                              73

                           SOUTHFIRST BANCSHARES, INC.
                                AND SUBSIDIARIES

             Notes to Consolidated Financial Statements (Continued)

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

2.   INVESTMENT SECURITIES (Continued)

     The Company sold securities available-for-sale for total proceeds of
     $20,206,296 and $541,176, resulting in gross realized gains of $123,736 and
     $15,705 in 1998 and 1997, respectively. There were no sales of investment
     securities available-for-sale in 1996.

     The scheduled maturities of securities held-to-maturity and securities
     (other than equity securities) available for sale by contractual maturity
     are shown below. Expected maturities will differ from contractual
     maturities because borrower may have the right to call or prepay
     obligations with or without call or prepayment penalties.

<TABLE>
<CAPTION>
                                        Held-to-Maturity              Available-for-Sale
                                     -----------------------     -----------------------------
                                     Amortized                    Amortized
                                       Cost       Fair Value         Cost          Fair Value
                                       ----       ----------         ----          ----------
     <S>                             <C>          <C>            <C>              <C>
     Due in one year or less         $880,901      $881,191      $   414,749      $   417,140
     Due from one to five years        90,205        90,964          501,725          513,522
     Due from five to ten years             0             0       10,443,239       10,523,348
     Due after ten years                    0             0       20,402,829       20,515,892
                                     --------      --------      -----------      -----------

                                     $971,106      $972,155      $31,762,542      $31,969,902
                                     ========      ========      ===========      ===========
</TABLE>

     Investment securities available-for-sale with a carrying amount of
     approximately $993,606 and $1,220,969 at September 30, 1998 and 1997,
     respectively, were pledged to secure public deposits as required by law and
     for other purposes required or permitted by law.


<PAGE>   75

                                                                              74

                           SOUTHFIRST BANCSHARES, INC.
                                AND SUBSIDIARIES

             Notes to Consolidated Financial Statements (Continued)

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

3.   LOANS

     Loans consisted of the following at September 30, 1998 and 1997:

<TABLE>
<CAPTION>
                                                                      1 9 9 8           1 9 9 7
                                                                      -------           -------
     <S>                                                            <C>               <C>
     Real estate mortgage loans:
       First mortgage loans:
            Single-family residential                               $ 73,239,327      $51,809,438
            Multi-family and commercial real estate                    1,837,214          390,186
       Second mortgage loans                                           6,215,903        1,046,212
       1-4 family construction loans                                  20,833,431       22,879,956
     Savings account loans                                             1,987,742          825,910
     Installment loans                                                 7,592,696        2,044,140
                                                                    ------------      -----------
            Total                                                    111,706,313       78,995,842
                                                                    ------------      -----------

     Deduct:
       Deferred loan fees and unearned credit
            life premiums                                                281,615          251,215
       Undisbursed portion of loans in process                         6,102,485        6,778,048
       Allowance for loan losses                                         732,021          284,324
                                                                    ------------      -----------
            Total deductions                                           7,116,121        7,313,587
                                                                    ------------      -----------

     Total loans receivable, net                                    $104,590,192      $71,682,255
                                                                    ============      ===========
</TABLE>


     Activity in the allowance for loan losses was as follows for the years
     ended September 30, 1998, 1997 and 1996:

<TABLE>
<CAPTION>
                                              1 9 9 8       1 9 9 7       1 9 9 6
                                              -------       -------       -------
     <S>                                     <C>           <C>           <C>
     Beginning balance                       $284,324      $250,714      $265,759
     Addition from business combination       487,611             0             0
     Provision charged to income               44,744        36,465         1,200
     Recovery of amounts charged off in
        prior years                            13,200         1,068         4,799
     Loans charged off                        (97,858)       (3,923)      (21,044)
                                             --------      --------      --------

     Ending balance                          $732,021      $284,324      $250,714
                                             ========      ========      ========
</TABLE>


                                   (Continued)


<PAGE>   76

                                                                              75

                           SOUTHFIRST BANCSHARES, INC.
                                AND SUBSIDIARIES

             Notes to Consolidated Financial Statements (Continued)

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

3.   LOANS (Continued)

     At September 30, 1998, the total recorded investment in impaired loans, all
     of which had allowances determined in accordance with SFAS No. 114 and No.
     118 amount to approximately $221,000. The average recorded investment in
     impaired loans amounted to approximately $227,000 for the year ended
     September 30, 1998. The allowance for loan losses related to impaired loans
     amounted to approximately $221,000 at September 30, 1998. Interest income
     on impaired loans of approximately $1,000 was recognized in 1998. No loans
     were considered impaired at September 30, 1997.

     The Company is not committed to lend additional funds to debtors whose
     loans have been modified.

4.   PREMISES AND EQUIPMENT

     Premises and equipment are summarized as follows at September 30, 1998 and
     1997:

<TABLE>
<CAPTION>
                                               1 9 9 8           1 9 9 7
                                               -------           -------
     <S>                                    <C>               <C>
     Land                                   $   410,966       $   235,966
     Buildings and improvements               3,285,914         1,621,319
     Furniture, fixtures and equipment        1,079,267         1,116,371
     Automobiles                                182,671           143,698
                                            -----------       -----------
                                              4,958,818         3,117,354
     Less: Accumulated depreciation          (1,055,510)       (1,337,068)
                                            -----------       -----------

     Premises and equipment, net            $ 3,903,308       $ 1,780,286
                                            ===========       ===========
</TABLE>


     Depreciation expense charged to operations was $291,443, $178,315 and
     $137,545 in 1998, 1997 and 1996, respectively.

5.   ACCRUED INTEREST RECEIVABLE

     Accrued interest receivable consists of the following at September 30, 1998
     and 1997:

<TABLE>
<CAPTION>
                                                    1 9 9 8         1 9 9 7
                                                    -------         -------
     <S>                                           <C>             <C>
     Loans                                         $  807,713      $493,510
     Investment securities held-to-maturity            11,650         1,968
     Investment securities available-for-sale         225,615       102,652
     Allowance for uncollected interest                     0       (68,630)
                                                   ----------      --------
        Total accrued interest receivable          $1,044,978      $529,500
                                                   ==========      ========
</TABLE>



<PAGE>   77

                                                                              76

                           SOUTHFIRST BANCSHARES, INC.
                                AND SUBSIDIARIES

             Notes to Consolidated Financial Statements (Continued)

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

6.   INVESTMENTS IN AFFILIATES

     In March 1995, the Company obtained a 50% ownership interest in Magnolia
     Title Services, Inc. (Magnolia) for an investment of $100,000. Magnolia
     provides title insurance and related services to various borrowers and
     lenders in the state of Alabama. In October 1995, the Company obtained a
     50% ownership interest in Meta Company (Meta) for an investment of
     $175,000. Meta is engaged in the financial planning business. In December
     1997, the Company sold its investment in Meta at no gain or loss. The
     Company financed the sale through a loan of approximately $96,000. The
     Company accounts for these investments under the equity method.

7.   LEASES

     The Company leases certain real estate and office equipment under operating
     leases expiring in various years through 2002. Minimum future rental
     payments under non-cancellable operating leases having remaining terms in
     excess of one year as of September 30, 1998 are as follows:

<TABLE>
<CAPTION>
                          Year Ending
                         September 30,                        Amount
                         <S>                                  <C>
                             1999                             $51,046
                             2000                              33,768
                             2001                               4,912
                             2002                                 360
                                                              -------

                                                              $90,086
                                                              =======
</TABLE>


8.   BUSINESS ACQUISITION

     On October 31, 1997, the Company acquired First Federal Savings & Loan
     Association of Chilton County ("Chilton County") in a business combination
     accounted for as a purchase. Chilton County was primarily engaged in
     banking services in Chilton County, Alabama. The results of operations of
     Chilton County are included in the accompanying financial statements since
     the date of acquisition. The total cost of the acquisition was
     approximately $5.2 million, which consisted of 128,143 shares of common
     stock issued at $14.25 per share and approximately $3.3 million in cash.
     The cost exceeded the fair value of the net assets of Chilton County by
     approximately $373,000, which is being amortized on the straight-line
     method over 15 years.

                                   (Continued)


<PAGE>   78

                                                                              77

                           SOUTHFIRST BANCSHARES, INC.
                                AND SUBSIDIARIES

             Notes to Consolidated Financial Statements (Continued)

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

8.   BUSINESS ACQUISITION (Continued)

     In connection with the acquisition, approximately $665,000 of the purchase
     price was allocated to premiums on loans purchased. These amounts are being
     amortized on the straight-line method over various periods ranging from 20
     to 35 months, of which approximately $235,000 has been amortized during the
     current period. Additionally, approximately $61,000 was allocated as a
     premium on deposits which is being amortized over approximately 12 months.
     The combined effects of the goodwill and premium amortization was to reduce
     income before taxes by approximately $202,000.

9.   DEPOSITS

     An analysis of deposit accounts, including the contractual interest rates
     at the end of the period, is as follows at September 30, 1998 and 1997:

<TABLE>
<CAPTION>
                                                      1 9 9 8          1 9 9 7
                                                      -------          -------
     <S>                                           <C>               <C>
     Demand accounts:
       Non interest bearing checking accounts      $  3,435,519      $ 1,255,745
       Interest bearing:
          NOW accounts                               11,354,173        5,676,548
          Money market demand                           324,380          402,249
                                                   ------------      -----------
               Total demand accounts                 15,114,072        7,334,542

     Passbook savings accounts                       14,769,304        9,380,308

     Certificate accounts                            94,000,300       43,837,686
                                                   ------------      -----------

          Total                                    $123,883,676      $60,552,536
                                                   ============      ===========
</TABLE>

     Certificate accounts greater than or equal to $100,000 were $3,301,654 at
     September 30, 1998 and $2,174,000 at September 30, 1997.

     Scheduled maturities of certificate accounts were as follows at September
     30, 1998 and 1997:

<TABLE>
<CAPTION>
                                      1 9 9 8          1 9 9 7
                                      -------          -------
     <S>                            <C>              <C>
     Less than one year             $66,580,505      $35,148,913
     One year to two years           22,731,066        5,385,165
     Two years to three years         4,069,474        2,990,190
     Three years to four years          352,587          313,418
     Four years to five years           266,668                0
                                    -----------      -----------

          Total                     $94,000,300      $43,837,686
                                    ===========      ===========
</TABLE>



                                   (Continued)


<PAGE>   79
                                                                              78

                           SOUTHFIRST BANCSHARES, INC.
                                AND SUBSIDIARIES

             Notes to Consolidated Financial Statements (Continued)

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

9.   DEPOSITS (Continued)

     Interest expense on deposits for the years ended September 30, 1998, 1997
     and 1996 were as follows:

<TABLE>
<CAPTION>
                                                            1 9 9 8          1 9 9 7         1 9 9 6
                                                            -------          -------         -------
     <S>                                                   <C>             <C>             <C>
     Demand accounts                                       $  288,352      $  204,718      $  252,178
     Passbook savings accounts                                327,840         249,157         279,365
     Certificate accounts                                   4,799,936       2,365,685       2,474,494
                                                           ----------      ----------      ----------

          Total                                            $5,416,128      $2,819,560      $3,006,037
                                                           ==========      ==========      ==========
</TABLE>

10.  BORROWED FUNDS

     The Company was liable to the Federal Home Loan Bank of Atlanta on the
     following advances at September 30, 1998 and 1997:

<TABLE>
<CAPTION>
     Maturity Date                                       Interest Rate             1 9 9 8                      1 9 9 7
     -------------                                       -------------             -------                      -------
     <S>                                                 <C>                     <C>                          <C>
     October 1997                                            6.17%               $         0                  $ 2,000,000
     October 1997                                            5.76%                         0                    4,014,017
     March 1998                                              8.54%                         0                      629,505
     May 1998                                                5.64%                         0                    5,000,000
     October 1998                                            5.89%                 3,000,000                            0
     March 1999                                              6.00%                 7,629,505                            0
     March 1999                                              8.58%                   286,044                      286,044
     March 2000                                              8.62%                   271,080                      271,080
     March 2001                                              8.68%                   257,439                      257,439
     September 2002                                          5.66%                 4,600,000                    4,600,000
                                                                                 -----------                  -----------
        Total (weighted average rate of
          5.86% in 1998 and 5.99% in 1997)                                       $16,044,068                  $17,058,085
                                                                                 ===========                  ===========
</TABLE>

     At September 30, 1998 and 1997, the advances were collateralized by
     first-mortgage residential loans with carrying values of approximately
     $72,288,000 and $22,745,000, respectively.

     The Company has a line-of-credit of up to $4,000,000 which bears interest
     at the prime lending rate plus one percent. The line-of-credit requires
     monthly interest payments and payment of the outstanding balance in October
     1998. At September 30, 1998, the prime lending rate was 8.5%. The
     outstanding balance on the line-of-credit was $5,000 and $1,435,301 at
     September 30, 1998 and 1997, respectively. The note is secured by the
     Company's stock in its subsidiary, First Federal of the South.

                                   (Continued)


<PAGE>   80
                                                                             79

                          SOUTHFIRST BANCSHARES, INC.
                                AND SUBSIDIARIES

             Notes to Consolidated Financial Statements (Continued)

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

10.   BORROWED FUNDS (Continued)

      The Company has a note payable to an individual in the amount of $120,000
      and $160,000 at September 30, 1998 and 1997, respectively, payable in
      equal installments over five years.

11.   INCOME TAX EXPENSE

      Income tax expense (benefit) for the years ended September 30, 1998, 1997
      and 1996 consists of the following:
      
<TABLE>
<CAPTION>
                                                                     1 9 9 8           1 9 9 7            1 9 9 6
                                                                   -----------       -----------       -----------
      <S>                                                          <C>               <C>               <C>
      Federal:
        Current                                                    $   329,558       $   207,767       $    42,250
        Deferred                                                        30,099            32,590            73,736
                                                                   -----------       -----------       -----------
                                                                       359,657           240,357           115,986
                                                                   -----------       -----------       -----------
      State:
        Current                                                         26,399            31,666           (12,455)
        Deferred                                                         2,213            31,042           (11,609)
                                                                   -----------       -----------       -----------
                                                                        28,612            62,708           (24,064)
                                                                   -----------       -----------       -----------

            Total                                                  $   388,269       $   303,065       $    91,922
                                                                   ===========       ===========       ===========
</TABLE>

      Income tax expense includes taxes related to investment security gains in
      the amount of $47,020 in 1998.

      The actual income tax expense differs from the "expected" income tax
      expense computed by applying the U.S. federal corporate income tax rate
      of 34% to income before income taxes as follows:

<TABLE>
<CAPTION>
                                                                     1 9 9 8           1 9 9 7            1 9 9 6
                                                                   -----------       -----------        -----------
      <S>                                                          <C>               <C>                <C>
      Computed "expected" income tax expense                       $   347,991       $   271,511        $    25,590
      Increase (reduction) in income tax resulting
      from:
        Compensation expense for ESOP                                        0                 0             57,240
        Management Recognition Plan                                          0                 0             24,539
        State tax, net of federal income tax benefit                    24,663            41,387            (15,882)
        FHLMC stock                                                          0                 0             (4,628)
        Other                                                           15,615            (9,833)             5,063
                                                                   -----------        ----------         ----------

            Total                                                  $   388,269        $  303,065         $   91,922
                                                                   ===========        ==========         ==========

      Effective tax rate                                                    38%               38%               122%
                                                                   ===========        ==========         ==========
</TABLE>

                                  (Continued)


<PAGE>   81


                                                                             80
                          SOUTHFIRST BANCSHARES, INC.
                                AND SUBSIDIARIES

             Notes to Consolidated Financial Statements (Continued)

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

11.   INCOME TAX EXPENSE

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

<TABLE>
<CAPTION>
                                                                                 1 9 9 8           1 9 9 7
                                                                               -----------       -----------
      <S>                                                                      <C>               <C>
      Deferred tax assets:
        Bad debts                                                              $   175,786       $         0
        Deferred compensation                                                       41,665            41,665
        Investment in equity of affiliate                                           66,624            57,033
        Other                                                                       13,130                 0
                                                                               -----------       -----------
             Total deferred tax assets                                             297,205            98,698
                                                                               -----------       -----------

      Deferred tax liabilities:
        Unrealized gain on investment securities
            available-for-sale                                                     945,037           659,112
        Bad debt expense                                                                 0             6,941
        Management Recognition Plan                                                 99,373            99,373
        FHLB stock                                                                 237,138           132,218
        Depreciation                                                               213,662                 0
        Prepaid expenses                                                            45,122            20,797
        Foreclosed real estate gain                                                 12,708            13,172
        Federal/state tax deduction on a cash basis                                  5,985             5,985
        Other                                                                            0               941
                                                                               ------------      -----------
             Total deferred tax liabilities                                      1,559,025           938,539
                                                                               -----------       -----------

             Net deferred tax liability                                        $ 1,261,820       $   839,841
                                                                               ===========       ===========
</TABLE>

      There was no valuation allowance at September 30, 1998 or 1997.

12.   EMPLOYEE BENEFIT PLANS

      Effective October 1, 1994, the Bank established the SouthFirst
      Bancshares, Inc. Employee Stock Ownership Plan (ESOP). The ESOP is
      available to all employees who have met certain age and service
      requirements. Contributions to the plan are determined by the Board of
      Directors and may be in cash or in common stock. The Corporation loaned
      $664,000 to the trustee of the ESOP, who purchased, on behalf of the
      trust of the ESOP, 66,400 shares of the shares sold by the Corporation in
      the public offering.


                                  (Continued)


<PAGE>   82


                                                                             81
                          SOUTHFIRST BANCSHARES, INC.
                                AND SUBSIDIARIES

             Notes to Consolidated Financial Statements (Continued)

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

12.   EMPLOYEE BENEFIT PLANS (Continued)

      The common stock of the Corporation acquired for the ESOP is held as
      collateral for the loan and is released for allocation to the ESOP
      participants as principal payments are made on the loan. The Bank makes
      contributions to the ESOP in amounts sufficient to make loan interest and
      principal payments and may make additional discretionary contributions.
      Contributions, which include dividends on ESOP shares, of $52,258,
      $116,075 and $222,834 were made to the ESOP in 1998, 1997 and 1996,
      respectively. During 1997, the Trustee distributed cash of $16,806 in
      lieu of shares to retiring participants.

      The ESOP's loan is repayable in ten annual installments of principal and
      interest. The interest rate is adjusted annually and is equal to the
      prime rate on each October 1st, beginning with October 1, 1995, until the
      note is paid in full. Principal and interest for the years ended
      September 30, 1998, 1997 and 1996 were $72,653, $101,632 and $222,834,
      respectively. The interest rate and principal outstanding at September
      30, 1998 were 8.50% and $336,348, respectively. These payments resulted
      in the commitment to release 4,000 shares in 1998, 7,739 shares in 1997,
      and the release and allocation to participants of 16,729 shares in 1996.
      The Company has recognized compensation expense, equal to the fair value
      of the committed-to-be released shares of $77,600, $111,520 and $209,112
      in 1998, 1997 and 1996, respectively. Excluding committed-to-be released
      shares, suspense shares at September 30, 1998 and 1997 equaled 30,800 and
      34,801, respectively. The fair value of the suspense shares at September
      30, 1998, was $502,440. These suspense shares are excluded from weighted
      average shares in determining earnings per share.

      During 1996, the Company adopted a Stock Option and Incentive Plan for
      directors and key employees of the Company. The exercise price cannot be
      less than the market price on the grant date and number of shares
      available for options cannot exceed 83,000. Stock appreciation rights may
      also be granted under the plan. As of September 30, 1996, options to
      acquire 83,000 shares had been granted at an exercise price of $14 per
      share. In 1998, 8,300 of these options were exercised and 4,150 had
      expired.

      During 1998, the Company adopted the 1998 Stock Option & Incentive Plan
      for directors and key employees of the Company. Under the 1998 plan,
      options to acquire 67,511 shares had been granted at an exercise price of
      $21 per share. None of the 1998 options had been exercised at September
      30, 1998. The term of the options are ten years and they vest equally
      over five years. The Company applies APB Opinion 25 in accounting for its
      stock option plans. Accordingly, no compensation cost has been recognized
      for the plan in 1998. Had compensation cost been determined on the basis
      of fair value pursuant to SFAS No. 123, net income and earnings per share
      would have been reduced as follows:

                                  (Continued)


<PAGE>   83


                                                                             82
                          SOUTHFIRST BANCSHARES, INC.
                                AND SUBSIDIARIES

             Notes to Consolidated Financial Statements (Continued)

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

12.   EMPLOYEE BENEFIT PLANS (Continued)

<TABLE>
<CAPTION>
                                                           1 9 9 8
                                                          ---------
        <S>                                               <C>
        Net income:
           As reported                                    $ 634,874
           Pro forma                                        602,059

        Primary earnings per share:
           As reported                                          .68
           Pro forma                                            .64

        Fully diluted earnings per share:
           As reported                                          .67
           Pro forma                                            .64
</TABLE>

      On November 15, 1995, the Company issued 33,200 shares of common stock
      (Initial Shares) to key employees under the terms of the Company's
      Management Recognition Plans (MRP's). These shareholders receive
      dividends on the shares and have voting rights. However, the sale or
      transferability of the shares is subject to the vesting requirements of
      the plan. These vesting requirements provide for the removal of the
      transferability restrictions upon the performance of employment services.
      The restrictions will be removed on 20 percent of the Initial Shares on
      each November 15 through the year 2000. Participants who terminate
      employment prior to satisfying the vesting requirements must forfeit the
      unvested shares and the accumulated dividends on the forfeited shares.
      The Company has recorded compensation expense equal to the fair value of
      the portion of vested shares attributable to 1998, 1997 and 1996 plus the
      fair value of 3,320 shares for which vesting was accelerated in 1996. In
      addition, the dividends paid on unvested shares are also reflected as
      compensation expense. Total compensation expense attributable to the
      MRP's in 1998, 1997 and 1996 was $115,934, $86,114 and $176,130,
      respectively.

      The Company also has a 401(k) plan that covers all employees who meet
      minimum age and service requirements. The plan provides for elective
      employee salary deferrals and currently the Company makes no matching
      contribution to the plan.

      The Company has entered into deferred compensation agreements with three
      of its senior officers, pursuant to which each officer will receive from
      the Company certain retirement benefits at age 65. Such benefits will be
      payable for 15 years to each officer or, in the event of death, to such
      officer's respective beneficiary. A portion of the retirement benefits
      will accrue each year until age 65 or, if sooner, until termination of
      employment. The annual benefits under these arrangements range from
      $30,000 to $65,000.

                                  (Continued)


<PAGE>   84


                                                                             83
                          SOUTHFIRST BANCSHARES, INC.
                                AND SUBSIDIARIES


             Notes to Consolidated Financial Statements (Continued)

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

12.   EMPLOYEE BENEFIT PLANS (Continued)

      The retirement benefits available under the deferred compensation
      agreements are unfunded. However, the Bank has purchased life insurance
      policies on the lives of these officers that will be available to the
      company and the Bank to provide, both, for retirement benefits and for
      key man insurance. The costs of these arrangements was $70,689 in 1998,
      $57,075 in 1997 and $51,045 in 1996.

      In addition to the deferred compensation arrangements discussed above,
      the Company entered into arrangements with two officers in April 1997,
      under which the Company issued a total of 21,135 shares of common stock
      to these officers. The shares vest ratably over the 15 year term of their
      employment contracts. The Company has recognized compensation expense
      equal to the fair value of the vested shares of $19,902 and $8,293 in
      1998 and 1997, respectively.

13.   RELATED PARTY TRANSACTIONS

      Certain directors and officers of the Company are loan customers of the
      Bank. Total loans outstanding to these persons at September 30, 1998 and
      1997 amounted to $1,200,556 and $1,319,687, respectively. The change from
      1997 to 1998 reflects payments of $228,431 and advances of $109,300.
      Management believes that such loans are made in the ordinary course of
      business at normal credit terms, including interest rate and collateral
      requirements, and do not represent more than a normal credit risk.

14.   COMMITMENTS AND CONTINGENCIES

      Outstanding loan commitments, all of which were fixed-rate single-family
      residential mortgage loans, were $1,320,340 and $2,282,925 at September
      30, 1998 and 1997, respectively.

      These financial instruments are not reflected on the accompanying
      statements of financial condition, but do expose the Company to credit
      risk. The Company's exposure to credit loss in the event of
      nonperformance by the other party to the financial instrument for
      commitments to extend credit is represented by the contractual amount of
      these instruments which was $1,320,340 and $2,282,925 at September 30,
      1998 and 1997, respectively. The Company uses the same credit policies in
      making commitments and conditional obligations as it does for on
      balance-sheet instruments.


                                  (Continued)


<PAGE>   85


                                                                             84
                          SOUTHFIRST BANCSHARES, INC.
                                AND SUBSIDIARIES

             Notes to Consolidated Financial Statements (Continued)

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

14.   COMMITMENTS AND CONTINGENCIES (Continued)

      These commitments to extend credit are agreements to lend to a customer
      as long as there is no violation of any condition established in the
      contract. Commitments generally have fixed expiration dates or other
      termination clauses and may require payment of a fee. Since some of the
      commitments are expected to expire without being drawn upon, the total
      commitment amounts do not necessarily represent future cash requirements.

      On December 21, 1993, the Bank filed a complaint against United States
      Fidelity & Guaranty Company (USF&G) and Robert R. Peoples in the Circuit
      Court of Talladega County, Alabama. The complaint alleged that USF&G
      breached its contractual obligations under a fidelity bond and that
      Robert R. Peoples defrauded the Bank. USF&G denied the Bank's claim under
      its fidelity bond and the Bank sought compensatory and punitive damages.
      Following a jury award in 1995, the Bank and USF&G entered into a
      settlement agreement in 1996 under which the Bank received $583,257, net
      of legal fees. This settlement is included in other income in 1996.

      The Company is involved in various legal actions arising in the normal
      course of business. In one such proceeding, management believes that an
      adverse judgment is reasonably possible and estimates that the pretax
      loss could be in the range of $50,000 to $100,000. In the opinion of
      management, based upon consultation with legal counsel, the ultimate
      resolution of all other proceedings will not have a material adverse
      effect upon the financial position or operations of the Company.

15.   RETAINED EARNINGS AND REGULATORY CAPITAL

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

                                  (Continued)


<PAGE>   86


                                                                             85
                          SOUTHFIRST BANCSHARES, INC.
                                AND SUBSIDIARIES

             Notes to Consolidated Financial Statements (Continued)

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

15.    RETAINED EARNINGS AND REGULATORY CAPITAL (Continued)

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

<TABLE>
<CAPTION>
                                                                          For Capital                     Well
                                                   Actual              Adequacy Purposes               Capitalized
                                                   ------              -----------------               -----------
                                             Amount      Ratio         Amount       Ratio          Amount       Ratio
                                             ------      -----         ------       -----          ------       -----
      <S>                                 <C>            <C>        <C>             <C>         <C>             <C>
      As of September 30, 1998:
        Total capital
           (to risk weighted assets)      $ 13,878,000   18.5%      >$ 6,004,000    >8.0%       >$ 7,504,000    >10.0%
                                                                    -               -           -               -
        Tier I capital
           (to risk weighted assets)        12,069,000   16.1%      >$ 3,002,000    >4.0%       >$ 4,503,000    > 6.0%
                                                                    -               -           -               - 
        Tier I capital
           (to average assets)              12,069,000    7.7%      >$ 6,258,000    >4.0%       >$ 7,822,000    > 5.0%
                                                                    -               -           -               - 

      As of September 30, 1997:
        Total capital
           (to risk weighted assets)      $ 13,289,000   23.9%      >$ 4,448,000    >8.0%       >$ 5,561,000    >10.0%
                                                                    -               -           -               - 
        Tier I capital
           (to risk weighted assets)        12,321,000   22.2%      >$ 2,224,000    >4.0%       >$ 3,336,000    > 6.0%
                                                                    -               -           -               - 
        Tier I capital
           (to average assets)              12,321,000   13.0%      >$ 3,786,000    >4.0%       >$ 4,733,000    > 5.0%
                                                                    -               -           -               - 
</TABLE>

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

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


<PAGE>   87


                                                                             86
                          SOUTHFIRST BANCSHARES, INC.
                                AND SUBSIDIARIES

             Notes to Consolidated Financial Statements (Continued)

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

16.   SHAREHOLDERS' RIGHTS PLAN

      In December 1997, the Company adopted a Stock Purchase Rights Plan that
      provides rights to holders of the Company's common stock to receive
      common stock rights under certain circumstances. The rights will become
      exercisable ten days after a person or group acquires 15% or more of the
      company's shares. If, after the rights become exercisable, the Company
      becomes involved in a merger, each right then outstanding (other than
      those held by the 15% holder) would entitle its holder to buy common
      stock of the Company worth twice the exercise price of each right. The
      rights expire in November 2007.

17.   FAIR VALUE OF FINANCIAL INSTRUMENTS

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

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

                                  (Continued)


<PAGE>   88


                                                                             87
                          SOUTHFIRST BANCSHARES, INC.
                                AND SUBSIDIARIES

             Notes to Consolidated Financial Statements (Continued)

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

17.   FAIR VALUE OF FINANCIAL INSTRUMENTS (Continued)

      Cash and Amounts Due from Depository Institutions - Fair value equals the
      carrying value of such assets due to their nature.

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

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

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

      Borrowed Funds - Fair value for the fixed-rate borrowings has been
      determined using discounted cash flows. The discount rate used is based
      on estimated current rates for advances with similar maturities. The
      carrying amount of the variable rate borrowings, due to the short
      repricing periods, approximate their fair value.

<TABLE>
<CAPTION>
                                                              1 9 9 8                             1 9 9 7
                                                              -------                             -------
                                                     Carrying          Estimated         Carrying         Estimated
                                                      Amount           Fair Value         Amount          Fair Value
                                                     --------          ----------        --------         ----------
       <S>                                         <C>                <C>               <C>               <C>
       Financial Assets:
         Cash amounts due from
            depository institutions                $ 9,213,906        $ 9,213,906       $2,448,123        $2,448,123
         Investments securities                     37,794,878         37,795,927       16,828,218        16,828,218
         Loans receivable, net                     104,590,192        111,129,000       71,682,225        74,730,000
         Accrued interest receivable                 1,044,978          1,044,978          529,500           529,500

       Financial Liabilities:
         Deposits                                  123,883,676        124,882,000       60,552,536        60,693,000
         Borrowed funds                             16,169,068         16,031,000       18,653,386        18,690,000
         Accrued interest payable                    1,071,183          1,071,183          859,111           859,111
</TABLE>


<PAGE>   89


                                                                             88
                          SOUTHFIRST BANCSHARES, INC.
                                AND SUBSIDIARIES

             Notes to Consolidated Financial Statements (Continued)

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

18.   PARENT COMPANY

      The condensed financial information for SouthFirst Bancshares, Inc.
      (Parent Company) is presented below:

                                 Parent Company
                            Condensed Balance Sheets
                          September 30, 1998 and 1997

<TABLE>
<CAPTION>
                                                                                                1 9 9 8          1 9 9 7
                                                                                             ------------     ------------
      ASSETS
      <S>                                                                                    <C>              <C>
      Cash and amounts due from depository institutions                                          $ 25,061     $     80,701
      Investment securities available for sale                                                    713,438          815,625
      Investment in financial institution subsidiary                                           13,878,031       13,340,727
      Investment in other subsidiaries                                                            401,854               --
      Investment in affiliates                                                                    144,617          192,560
      Other assets                                                                              1,866,749        1,707,253
                                                                                             ------------     ------------

          Total Assets                                                                       $ 17,029,750     $ 16,136,866
                                                                                             ============     ============

      LIABILITIES AND STOCKHOLDERS' EQUITY

      Liabilities:
         Borrowed funds (including $1,000,000 from financial
              institution in 1998)                                                           $  1,005,000     $  1,595,301
         Other liabilities                                                                        354,135          918,231
                                                                                             ------------     ------------
            Total liabilities                                                                   1,359,135        2,513,532
                                                                                             ------------     ------------
      Stockholders' equity:
          Common stock, $ .01 par value, 2,000,000 shares authorized; 999,643
              shares issued and 914,432 shares outstanding in 1998;
              863,200 shares issued and 812,799 shares outstanding in 1997                          9,996            8,632
         Additional paid-in capital                                                             9,810,963        7,792,748
         Treasury stock                                                                          (867,087)        (198,392)
         Deferred compensation on common stock employee benefit plans                            (778,508)        (914,604)
         Retained earnings                                                                      5,953,346        5,815,352
         Unrealized gain on investment securities available-for-sale,
             net of tax                                                                         1,541,905        1,119,598
                                                                                             ------------     ------------
               Total stockholders' equity                                                      15,670,615       13,623,334
                                                                                             ------------     ------------

            Total Liabilities and Stockholders' Equity                                       $ 17,029,750     $ 16,136,866
                                                                                             ============     ============
</TABLE>

                                  (Continued)


<PAGE>   90


                                                                             89
                          SOUTHFIRST BANCSHARES, INC.
                                AND SUBSIDIARIES

             Notes to Consolidated Financial Statements (Continued)

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

18.   PARENT COMPANY (Continued)

                                 Parent Company
                       Condensed Statements of Operations
                 Years Ended September 30, 1998, 1997 and 1996


<TABLE>
<CAPTION>
                                                                     1 9 9 8          1 9 9 7           1 9 9 6
                                                                   -----------       ---------         ---------
<S>                                                                <C>               <C>               <C>
Cash dividends from financial institution subsidiary               $ 2,892,976       $      --         $      --
Interest and dividend income                                            53,688          73,225            99,603
                                                                   -----------       ---------         ---------

    Total income                                                     2,946,664          73,225            99,603
                                                                   -----------       ---------         ---------

Expenses:
   Interest on borrowed funds                                          225,485         109,277            21,682
   Equity in loss of affiliates                                         26,279          61,977            66,773
   Compensation and benefits                                            28,500          25,000            11,250
   Management fee                                                       90,000          90,000            90,000
   Other                                                               153,249          99,005           259,515
                                                                   -----------       ---------         ---------

                                                                       523,513         385,259           449,220
                                                                   -----------       ---------         ---------

Income (loss) before income taxes                                    2,423,151        (312,034)         (349,617)

Income tax benefit                                                     166,269         107,509           128,198
                                                                   -----------       ---------         ---------

Income (loss) before equity in undistributed
   earnings of subsidiaries                                          2,589,420        (204,525)         (221,419)
                                                                   -----------       ---------         ---------

Equity in undistributed earnings of subsidiaries
   (dividends in excess of earnings):
        Financial institution                                       (1,978,410)        696,346           204,763
        Other                                                           23,864           3,678                --
                                                                   -----------       ---------         ---------

                                                                    (1,954,546)        700,024           204,763
                                                                   -----------       ---------         ---------

Net income (loss)                                                  $   634,874       $ 495,499         $ (16,656)
                                                                   ===========       =========         =========
</TABLE>

                                  (Continued)

<PAGE>   91


                                                                             90
                          SOUTHFIRST BANCSHARES, INC.
                                AND SUBSIDIARIES

             Notes to Consolidated Financial Statements (Continued)

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

18.   PARENT COMPANY (Continued)

                                 Parent Company
                       Condensed Statements of Cash Flows
                 Years Ended September 30, 1998, 1997 and 1996

<TABLE>
<CAPTION>
                                                                     1 9 9 8          1 9 9 7            1 9 9 6
                                                                   -----------     -----------         ----------
<S>                                                                <C>               <C>               <C>
Operating Activities:
    Net income (loss)                                              $   634,874     $   495,499         $  (16,656)
    Adjustments to reconcile net income (loss) to
    cash from operating activities:
        Equity in undistributed earnings of subsidiaries              (938,430)       (696,346)          (204,763)
        Compensation expense on ESOP and MRP                           213,436         205,927            318,012
        Equity in losses of unconsolidated affiliates                   26,279          61,977             66,773
        (Increase) decrease in other assets                            159,496      (1,072,639)          (510,437)
        Increase (decrease) in other liabilities                      (564,096)        767,141             13,242
                                                                   -----------     -----------         ----------
           Net cash  used in operating activities                     (468,441)       (238,441)          (333,829)
                                                                   -----------     -----------         ----------

Investing Activities:
    Purchase of investment securities                                       --              --           (270,385)
    Proceeds from sale of investment securities                        102,187              --                 --
    Investment in subsidiaries, net of dividends received            1,928,626              --                 --
    Investment in affiliates, net of sale proceeds                      21,664         (70,000)          (175,000)
                                                                   -----------     -----------         ----------
        Net cash provided (used) by investing activities             2,052,477         (70,000)          (445,385)
                                                                   -----------     -----------         ----------

Financing Activities:
    Issuance of common stock                                           116,200          65,893                 --
    Acquisition of ESOP shares                                              --         (16,806)                --
    Proceeds from borrowed funds                                            --         695,048            900,253
    Repayment on borrowed funds                                       (590,301)             --                 --
    Cash dividends paid                                               (496,880)       (370,448)        (1,917,558)
    Acquisition of treasury stock                                     (668,695)        (34,606)          (500,802)
                                                                   -----------     -----------         ----------
        Net cash provided (used) by financing activities            (1,639,676)        339,081         (1,518,107)
                                                                   -----------     -----------         ----------

Net increase (decrease) in cash and amounts due from
    depository institutions                                            (55,640)         30,640         (2,297,321)

Cash and amounts due from depository institutions at
    beginning of year                                                   80,701          50,061          2,347,382
                                                                   -----------     -----------         ----------

Cash and amounts due from depository institutions
    at end of year                                                 $    25,061     $    80,701         $   50,061
                                                                   ===========     ===========         ==========
</TABLE>

<PAGE>   92


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

            On August 20, 1998, SouthFirst dismissed its independent auditors,
KPMG Peat Marwick LLP ("KPMG"), and on the same date engaged the firm of Jones &
Kirkpatrick, P.C. ("Jones & Kirkpatrick") as its independent auditors for the
fiscal year ending September 30, 1998. Each of these actions was approved by the
audit committee of the Board of Directors of SouthFirst.

            The report of KPMG on the financial statements of the Company for
the fiscal years ended September 30, 1997 and 1996 did not contain any adverse
opinion or a disclaimer of opinion, nor was it qualified or modified as to audit
scope or accounting principles.

            In connection with the audit of the fiscal years ended September 30,
1997 and 1996 and for the unaudited interim period through August 20, 1998,
there were no disagreements with KPMG on any matter of accounting principle or
practice, financial statement disclosure, or audit procedure or scope which
disagreement, if not resolved to the satisfaction of KPMG, would have caused it
to make reference to the subject matter of the disagreement in its report.

            KPMG has furnished the Company with a letter addressed to the
Securities and Exchange Commission stating that it does not disagree with any of
the above statements, a copy of which has been filed as an exhibit to the
Current Report on Form 8-K dated August 20, 1998.

                                    PART III

            The information required by Part III of Form 10-KSB is, pursuant to
General Instruction E(3) of Form 10-KSB, incorporated by reference from the
Company's definitive proxy statement (the "Proxy Statement") to be filed
pursuant to Regulation 14A with the Commission not later than 120 days after the
end of the fiscal year covered by this form.

ITEM 9.     DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.

            The information responsive to this item is incorporated by reference
from the section entitled "Election of Directors" contained in the Proxy
Statement.

ITEM 10.    EXECUTIVE COMPENSATION.

            The information responsive to this item is incorporated by reference
from the section entitled "Executive Compensation" contained in the Proxy
Statement.

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

            The information responsive to this item is incorporated by reference
from the section entitled "Security Ownership of Certain Beneficial Owners and
Management" contained in the Proxy Statement.


                                       91
<PAGE>   93

ITEM 12.    CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

            No directors, executive officers, or immediate family members of
such individuals were engaged in transactions with SouthFirst or First Federal
(other than loans) involving more than $60,000 during fiscal year ended
September 30, 1998. First Federal, like many financial institutions, has
followed a policy of granting various types of loans to officers, directors and
employees. The loans have been made in the ordinary course of business and on
substantially the same terms, including interest rates and collateral, as those
prevailing at the time for comparable transactions with First Federal's other
customers, and do not involve more than the normal risk of collectibility, nor
present other unfavorable features. All loans by First Federal to its officers
and executive officers are subject to OTS regulations restricting loans and
other transactions with affiliated persons of First Federal. In addition, all
future credit transactions with such directors, officers and related interests
of SouthFirst and First Federal will be on substantially the same terms as, and
following credit underwriting procedures that are not less stringent than, those
prevailing at the time for comparable transactions with unaffiliated persons and
must be approved by a majority of the directors of SouthFirst, including a
majority of the disinterested directors. At September 30, 1998, the aggregate of
all loans by First Federal to its officers, directors, and related interests was
$1,021,000.

ITEM 13.   EXHIBITS AND REPORTS ON FORM 8-K

            (A).  EXHIBITS.

            The following exhibits are filed with or incorporated by reference
into this report. The exhibits which are denominated by an asterisk (*) were
previously filed as a part of, and are hereby incorporated by reference, from
SouthFirst's: Registration Statement on Form S-1 under the Securities Act of
1933 Registration No. 33-80730 ("1994 S-1"); Registration Statement on From S-8
under the Securities Act of 1933, Registration No. 333-4534 ("Plan "A" S-8");
Registration Statement on From S-8 under the Securities Act of 1933,
Registration No. 333-4536 ("Plan "B" S-8"); Registration Statement on From S-8,
Registration No. 333-4538 ("Option Plan S-8"); Annual Report on Form 10-K for
the year ended September 30, 1995 ("1995 10-K"); or Annual Report on Form 10-K
for the year ended September 30, 1997. Unless otherwise indicated, the exhibit
number corresponds to the exhibit number in the referenced document.

<TABLE>
<CAPTION>
              Exhibit No.  Description of Exhibit
              -----------  -----------------------
              <S>          <C>
                 3.1*      Amended and Restated Certificate of Incorporation 
                           (1994 S-1).
                 3.2*      Bylaws (1994 S-1, Exhibit 3.2).

                 4*        Form of Common Stock Certificate (1994 S-1).

                 10.1*     Employment Agreement dated as of October 1,
                           1997 between SouthFirst Bancshares, Inc. and
                           Donald C. Stroup (1997 Form 10-K).

                 10.2*     Employment Agreement dated as of October 1,
                           1997 between SouthFirst Bancshares, Inc. and
                           Joe K. McArthur (1997 Form 10-K).

                 10.3*     Employment Agreement dated as of October 1, 1997 
                           between First Federal of the South and Donald C. 
                           Stroup (1997 Form 10-K).
</TABLE>



                                       92
<PAGE>   94


<TABLE>
                 <S>       <C>
                 10.4*     Employment Agreement dated as of October 1, 1997 
                           between First Federal of the South and Joe K. 
                           McArthur (1997 Form 10-K).

                 10.5      Employment Agreement dated as of October 31,
                           1997 between First Federal of the South and
                           Bobby R. Cook (1997 Form 10-K).

                 10.5.1*   Form of Management Recognition Plan A (1994 S-1, 
                           Exhibit 10.5).

                 10.5.2*   Form of Management Recognition Plan A, as amended 
                           (1995 Form 10-K).

                 10.5.3*   Management Recognition Plan A Restated and Continued 
                           (Plan "A" S-8, Exhibit 4.1).

                 10.6.1*   Form of Management Recognition Plan B (1994 S-1, 
                           Exhibit 10.6).

                 10.6.2*   Form of Management Recognition Plan B, as amended 
                           (1995 Form 10-K).

                 10.6.3*   Management Recognition Plan B, Restated and Continued 
                           (Plan "B" S-8, Exhibit 4.1).

                 10.7.1*   Form of Stock Option and Incentive Plan (1994 S-1, 
                           Exhibit 10.7)  (1995 Form 10-K.)

                 10.7.2*   Form of Stock Option and Incentive Plan, as amended 
                           (1995 Form 10-K).

                 10.7.3*   Stock Option and Incentive Plan, Restated and 
                           Continued (Option Plan S-8, Exhibit 4.1).

                 10.7.4*   Form of Incentive Stock Option Agreement (Option Plan
                           S-8, Exhibit 4.2).

                 10.8*     Form of SouthFirst Bancshares, Inc. Employee Stock 
                           Ownership Plan (1994 S-1, Exhibit 10.8).

                 10.9*     Deferred Compensation Agreement between First Federal 
                           of the South and Joe K. McArthur (1995 Form 10-K).

                 10.10*    Deferred Compensation Agreement between First Federal 
                           of the South and Donald C. Stroup (1995 Form 10-K).

                 10.11     Employment Agreement dated as of January 1, 1998 
                           between First Federal of the South and Jimmy C. 
                           Maples.

                 11        Statement Regarding Computation of Per Share Earnings.

                 21        Subsidiaries of Registrant.

                 23.1      Consent of Jones and Kirkpatrick, P.C.
</TABLE>



                                       93
<PAGE>   95



<TABLE>
                 <S>        <C>
                 23.2       Consent of KPMG Peat Marwick LLP

                 27         Financial Data Schedule (for SEC use only)
</TABLE>

            (B)  REPORTS ON FORM 8-K

            SouthFirst filed one report on Form 8-K during the last quarter of
the fiscal year ended September 30, 1998, on August 20, 1998, reporting its
dismissal of KPMG Peat Marwick LLP as its independent auditors and engagement of
Jones & Kirkpatrick, P.C. as independent auditors.


                                       94
<PAGE>   96
                                   SIGNATURES

         In accordance with Section 13 or 15(d) of the Exchange Act, the
registrant caused this report to be signed on its behalf by the undersigned,
thereunto duly authorized, in the City of Sylacauga, State of Alabama, on the
29th day of December, 1998.

                                  SOUTHFIRST BANCSHARES, INC.


                                  By: /s/ Donald C. Stroup
                                     -------------------------------------
                                     Donald C. Stroup
                                     President and Chief Executive Officer

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

<TABLE>
<CAPTION>
          Signature                            Title                            Date
          ---------                            -----                            ----
       <S>                            <C>                                <C>
       /s/ Donald C. Stroup
       ----------------------------   Chairman, President and
       Donald C. Stroup               Chief Executive Officer
                                      (principal executive officer)      December 29, 1998

       /s/ Joe K. McArthur
       ----------------------------   Executive Vice President,
       Joe K. McArthur                Chief Operating Officer,
                                      Chief Financial Officer,
                                      Secretary/Treasurer and director
                                      (principal accounting officer)     December 29, 1998

       /s/ Bobby R. Cook
       ----------------------------   Director                           December 29, 1998
       Bobby R. Cook

       /s/ H. David Foote, Jr.
       ----------------------------   Director                           December 29, 1998
       H. David Foote, Jr.

       /s/ J. Malcomb Massey
       ----------------------------   Director                           December 29, 1998
       J. Malcomb Massey

       /s/ Allen Gray McMillan, III
       ----------------------------   Director                           December 29, 1998
       Allen Gray McMillan, III

       /s/ John T. Robbs
       ----------------------------   Director                           December 29, 1998
       John T. Robbs

       /s/ Charles R. Vawter, Jr.
       ----------------------------   Director                           December 29, 1998
       Charles R. Vawter, Jr.
</TABLE>



                                         95

<PAGE>   97



                           SOUTHFIRST BANCSHARES, INC.

EXHIBIT INDEX

<TABLE>
<CAPTION>
EXHIBIT NO.                                     DESCRIPTION OF EXHIBIT                           
-----------         -----------------------------------------------------------------------------
<S>                 <C>
10.5                Employment Agreement dated as of January 1, 1998 between First Federal of the
                    South and Bobby R. Cook.
10.11               Employment Agreement dated as of January 1, 1998 between First Federal of the
                    South and Jimmy C. Maples.
11                  Statement Regarding Computation of Per Share Earnings.
21                  Subsidiaries of Registrant.
23.1                Consent of Jones and Kirkpatrick, P.C.
23.2                Consent of KPMG Peat Marwick LLP
27                  Financial Data Schedule. (for SEC use only).
</TABLE>



                                       96