Highlands Bankshares 10Q 2015 Q4 Quarterly report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

[X] Quarterly Report Pursuant to Section 13 or 15(d)

of the Securities Exchange Act of 1934

For the quarterly period ended September 30, 2015

[ ] 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: 0-27622

HIGHLANDS BANKSHARES, INC.

(Exact name of registrant as specified in its charter)

Virginia (State or other jurisdiction of incorporation or organization)	54-1796693 (I.R.S. Employer Identification No.)
P.O. Box 1128 Abingdon, Virginia (Address of principal executive offices)	24212-1128 (Zip Code)

276-628-9181

(Registrant’s telephone number, including area code)

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 whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes [ X ] No [ ]

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or smaller reporting company (See definition of “large accelerated filer, accelerated filer and smaller reporting company” in Rule 12b-2 of the Act). Large Accelerated Filer [ ] Accelerated Filer [ ] Non-Accelerated Filer [ ] Smaller Reporting Company [X]

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes [ ] No [X ]

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

7,851,780 shares of common stock, par value $0.625 per share,

outstanding as of November 13, 2015

Highlands Bankshares, Inc.

FORM 10-Q

For the Quarter Ended September 30, 2015

INDEX


PART I. FINANCIAL INFORMATION	PAGE

Item 1. Financial Statements
	2
Consolidated Balance Sheets at September 30, 2015 (Unaudited) and December 31, 2014
	2

Consolidated Statements of Income (Unaudited) for the Three Months and Nine Months Ended September 30, 2015 and 2014	3

Consolidated Statements of Comprehensive Income (Unaudited) for the Three Months and Nine Months Ended September 30, 2015 and 2014	4
Consolidated Statements of Cash Flows (Unaudited) for the Nine Months Ended September 30, 2015 and 2014	5

Consolidated Statements of Changes in Stockholders’ Equity (Unaudited) for the Three Months and Nine Months Ended September 30, 2015 and 2014	6-7

Notes to Consolidated Financial Statements (Unaudited)	8-39

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations	39-45

Item 3. Quantitative and Qualitative Disclosures About Market Risk	45

Item 4. Controls and Procedures	45

PART II. OTHER INFORMATION

Item 1. Legal Proceedings	46

Item 1A. Risk Factors	46

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds	46

Item 3. Defaults Upon Senior Securities	46

Item 4. Mine Safety Disclosures	46

Item 5. Other Information	46

Item 6. Exhibits	46

SIGNATURES AND CERTIFICATIONS	47

PART I.

FINANCIAL INFORMATION

ITEM 1. Financial Statements

Consolidated Balance Sheets

(Amounts in thousands)

	(Unaudited) September 30, 2015	(Note 1) December 31, 2014
ASSETS
Cash and due from banks	$ 20,566	$ 15,018
Federal funds sold	28,247	40,792

Total Cash and Cash Equivalents	48,813	55,810

Investment securities available for sale (amortized cost $84,267 at September 30, 2015, $84,191 at December 31, 2014)	84,464	84,335
Other investments, at cost	6,599	6,767
Loans, net of allowance for loan losses of $5,333 at September 30, 2015, $5,477 at December 31, 2014	416,813	401,520
Premises and equipment, net	20,659	20,236
Deferred tax assets	11,470	10,744
Interest receivable	2,310	2,235
Bank owned life Insurance	14,482	14,183
Other real estate owned	7,277	6,685
Other assets	2,557	2,599

Total Assets	$ 615,444	$ 605,114

LIABILITIES AND STOCKHOLDERS’ EQUITY

LIABILITIES

Deposits:
Non-interest bearing	$ 118,486	$ 118,557
Interest bearing	372,883	364,940

Total Deposits	491,369	483,497

Interest, taxes and other liabilities	1,566	1,014
Other short-term borrowings	20,051	20,051
Long-term debt	47,712	47,750

Total Other Liabilities	69,329	68,815

Total Liabilities	560,698	552,312

STOCKHOLDERS’ EQUITY

Common stock (7,851 shares issued and outstanding)	4,907	4,907
Preferred stock (2,092 shares issued and outstanding)	4,184	4,184
Additional paid-in capital	17,947	18,180
Retained earnings	27,579	25,436
Accumulated other comprehensive income	129	95
Total Stockholders’ Equity	54,746	52,802

Total Liabilities and Stockholders’ Equity	$ 615,444	$ 605,114

See accompanying Notes to Consolidated Financial Statements

Consolidated Statements of Income

(Amounts in thousands, except per share data)

(Unaudited)

	Nine Months Ended September 30, 2015			Nine Months Ended September 30, 2014			Three Months Ended September 30, 2015			Three Months Ended September 30, 2014
INTEREST INCOME
Loans receivable and fees on loans	$	15,921		$	16,045		$	5,347		$	5,458
Securities available for sale:
Taxable		873			691			281			277
Exempt from taxable income		281			371			84			124
Other investment income		161			151			48			50
Federal funds sold		66			110			20			32

Total Interest Income		17,302			17,368			5,780			5,941

INTEREST EXPENSE
Deposits		1,662			1,933			545			630
Other borrowed funds		1,774			2,077			598			621

Total Interest Expense		3,436			4,010			1,143			1,251

Net Interest Income		13,866			13,358			4,637			4,690

Provision for Loan Losses		697			1,248			215			352

Net Interest Income after Provision for Loan Losses		13,169			12,110			4,422			4,338

NON-INTEREST INCOME
Securities gains, net		16			-			-			-
Service charges on deposit accounts		1,260			1,431			439			485
Other service charges, commissions and fees		1,220			1,248			391			396
Other operating income		433			564			152			203
Total Non-Interest Income		2,929			3,243			982			1,084

NON-INTEREST EXPENSE
Salaries and employee benefits		7,598			7,424			2,585			2,451
Occupancy expense of bank premises		865			778			271			202
Furniture and equipment expense		1,026			862			350			290
Other operating expense		4,528			4,105			1,794			1,444
Foreclosed Assets – Write-down and operating expenses		684			1,234			(139	)		462
Total Non-Interest Expense		14,701			14,403			4,861			4,849

Income Before Income Taxes		1,397			950			543			573

Income Tax Expense (Benefit)		(746	)		(983	)		114			47

Net Income	$	2,143		$	1,933		$	429		$	526

Basic Earnings Per Common Share – Weighted Average	$	0.27		$	0.29		$	0.05		$	0.07

Earnings Per Common Share – Assuming Dilution	$	0.22		$	0.22		$	0.04		$	0.05

See accompanying Notes to Consolidated Financial Statements

Consolidated Statements of Comprehensive Income

(Amounts in thousands)

(Unaudited)

	Nine Months Ended September 30, 2015			Nine Months Ended September 30, 2014


Net Income	$	2,143		$	1,933

Other Comprehensive Income
Unrealized gains on securities during the period		68			815
Less: reclassification adjustment for gains included in net income		(16	)		-
Other Comprehensive Income, before tax		52			815
Income tax expense related to other comprehensive income		(18	)		(277	)
Other Comprehensive Income		34			538
Comprehensive Income	$	2,177		$	2,471

	Three Months Ended September 30, 2015		Three Months Ended September 30, 2014


Net Income	$	429	$	526

Other Comprehensive Income
Unrealized gains (losses) on securities during the period		326		(201)
Less: reclassification adjustment for losses included in net income		-		-
Other Comprehensive Income (Loss), before tax		326		(201)
Income tax (expense) benefit related to other comprehensive income		(111)		68
Other Comprehensive Income (Loss)		215		(133)
Comprehensive Income	$	644	$	393

See accompanying Notes to Consolidated Financial Statements

Consolidated Statements of Cash Flows

(Amounts in thousands)

(Unaudited)

	Nine Months Ended		Nine Months Ended
	September 30, 2015		September 30, 2014
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income	$	2,143	$	1,933
Adjustments to reconcile net income to net cash provided by operating activities
Provision for loan losses		697		1,248
Depreciation and amortization		749		653
Net realized (gains) losses on available for sale securities		(16)		-
Net amortization on securities		798		475
Amortization of capital issue costs		-		18
(Increase) decrease in interest receivable		(75)		(149)
Valuation adjustment of other real estate owned		(155)		386
Valuation adjustment of deferred tax assets		(1,000)		(1,000)
Decrease (increase) in other assets		188		(1,270)
Increase (decrease) in interest, taxes and other liabilities		552		(1,210)

Net cash provided by operating activities		3,881		1,084

CASH FLOWS FROM INVESTING ACTIVITIES:
Securities available for sale:
Proceeds from sale of securities		1,025		-
Proceeds from maturities of debt and equity securities		13,992		6,597
Purchase of securities		(15,875)		(34,177)
(Purchases) sales of other investments		168		(2,047)
Net increase in loans		(19,635)		(6,185)
Proceeds from sales of other real estate owned		2,705		3,141
Proceeds from Cash Surrender Value of Life Insurance		-		360
Premises and equipment expenditures		(1,092)		(763)

Net cash used in investing activities		(18,712)		(33,074)

CASH FLOWS FROM FINANCING ACTIVITIES:
Issuance of Common Stock		-		9,912
Issuance of Preferred Stock		-		7,168
Net decrease in time deposits		(9,645)		(11,110)
Net increase (decrease) in demand, savings and other deposits		17,517		10,785
Decrease in short-term borrowings		-		(3,450)
Decrease in long-term debt		(38)		(38)
Redemption of Capital Securities		-		(3,150)
Net cash provided by financing activities		7,834		10,117

Net decrease in cash and cash equivalents		(6,997)		(21,783)
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD		55,810		83,995

CASH AND CASH EQUIVALENTS AT END OF PERIOD	$	48,813	$	62,122

SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Cash paid during the period for:
Interest	$	3,458	$	5,221

SUPPLEMENTAL DISCLOSURE OF NONCASH TRANSACTIONS
Transfer of loans to other real estate owned	$	3,645	$	2,843
Loans originated from sales of other real estate owned	$	130	$	561

See accompanying Notes to Consolidated Financial Statements

Consolidated Statements of Changes in Stockholders’ Equity

(Amounts in thousands)

(Unaudited)

Three Months Ended September 30							Accumulated
					Additional		Other	Total
	Common Stock		Preferred Stock		Paid In	Retained	Comprehensive	Stockholders’
	Shares	Par Value	Shares	Par Value	Capital	Earnings	Income (Loss)	Equity

Balance, June 30, 2014	7,684	$ 4,803	2,048	$4,096	$ 18,541	$ 24,317	$ (163)	$ 51,594

Net income	-	-			-	526	-	526

Common Stock Issuance	159	99			457			556

Preferred Stock Issuance			-	-	-			-

Other comprehensive income	-	-			-	-	(133)	(133)

Balance September 30, 2014	7,843	$ 4,902	2,048	$4,096	$ 18,998	$ 24,843	$ (296)	$ 52,543

Balance, June 30, 2015	7,851	$ 4,907	2,092	$ 4,184	$ 17,947	$ 27,150	$ (86)	$ 54,102

Net income	-	-			-	429	-	429

Other comprehensive income (loss)	-	-			-	-	215	215

Balance, September 30, 2015	7,851	$ 4,907	2,092	$4,184	$ 17,947	$ 27,579	$ 129	$ 54,746

Consolidated Statements of Changes in Stockholders’ Equity

(Amounts in thousands)

(Unaudited)

Nine Months Ended September 30							Accumulated
					Additional		Other	Total
	Common Stock		Preferred Stock		Paid-in	Retained	Comprehensive	Stockholders’
	Shares	Par Value	Shares	Par Value	Capital	Earnings	Income (Loss)	Equity

Balance, December 31, 2013	5,011	$ 3,132	-	-	$ 7,783	$ 22,910	$ (834)	$ 32,991


Net income	-	-			-	1,933	-	1,933

Common Stock Issuance	2,832	1,770			8,142			9,912

Preferred Stock Issuance			2,048	4,096	3,073			7,169



Other comprehensive income	-	-			-	-	538	538

Balance, September 30, 2014	7,843	$ 4,902	2,048	$4,096	$ 18,998	$ 24,843	$ (296)	$ 52,543


Balance, December 31, 2014	7,851	$ 4,907	2,092	$ 4,184	$ 18,180	$ 25,436	$ 95	$ 52,802


Net income	-	-			-	2,143	-	2,143

Additional Paid In Capital					(233)	-	-	(233)

Other comprehensive income (loss)	-	-			-	-	34	34

Balance, September 30, 2015	7,851	$ 4,907	2,092	$4,184	$ 17,947	$ 27,579	$ 129	$ 54,746

See accompanying Notes to Consolidated Financial Statements

Notes to Consolidated Financial Statements

(Unaudited)

(in thousands, except share, per share and percentage data)

Note 1 - General

The consolidated financial statements of Highlands Bankshares, Inc. (the “Company”) conform to United States generally accepted accounting principles and to banking industry practices. The accompanying consolidated interim financial statements are unaudited. In the opinion of management, all adjustments necessary for a fair presentation of the consolidated financial statements have been included. All such adjustments are of a normal and recurring nature. The consolidated balance sheet as of December 31, 2014 has been extracted from the audited financial statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2014 (the “2014 Form 10-K”). The notes included herein should be read in conjunction with the notes to consolidated financial statements included in the 2014 Form 10-K. The results of operations for the three-month and nine-month periods ended September 30, 2015 are not necessarily indicative of the results to be expected for the full year.

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

Note 2 - Loans and Allowance for Loan Losses (amounts in thousands)

The composition of net loans is as follows:

	September 30, 2015	December 31, 2014
Real Estate Secured:
Residential 1-4 family	$ 194,412	$ 186,829
Multifamily	24,000	21,131
Construction and Land Loans	17,836	18,518
Commercial, Owner Occupied	69,390	70,748
Commercial, Non-owner occupied	33,794	32,173
Second mortgages	8,011	8,075
Equity lines of credit	6,103	6,499
Farmland	11,522	8,246
	365,068	352,219

Secured (other) and unsecured
Personal	20,921	20,901
Commercial	33,834	31,586
Agricultural	2,859	2,683
	57,614	55,170

Overdrafts	227	285

	422,909	407,674
Less:
Allowance for loan losses	5,333	5,477
Net deferred fees	763	677
	6,096	6,154

Loans, net	$ 416,813	$ 401,520

Notes to Consolidated Financial Statements

(Unaudited)

(in thousands, except share, per share and percentage data)

The following table is an analysis of past due loans as of September 30, 2015:

	30-59 Days Past Due	60-89 Days Past Due	Greater Than 90 Days	Total Past Due	Current	Total Financing Receivables	Recorded Investment > 90 Days and Accruing

Real Estate Secured
Residential 1-4 family	$ 3,305	$ 1,775	$ 2,201	$ 7,281	$ 187,131	$ 194,412	$ -
Equity lines of credit	11	22	-	33	6,070	6,103	-
Multifamily	-	-	-	-	24,000	24,000	-
Farmland	27	642	57	726	10,796	11,522	-
Construction, Land Development, Other Land Loans	39	17	72	128	17,708	17,836	-
Commercial Real Estate- Owner Occupied	2,253	68	3,683	6,004	63,386	69,390	-
Commercial Real Estate- Non Owner Occupied	-	-	-	-	33,794	33,794	-
Second Mortgages	46	64	75	185	7,826	8,011	-
Non Real Estate Secured
Personal	391	261	115	767	20,381	21,148	-
Commercial	196	114	299	609	33,225	33,834	-
Agricultural	23	-	-	23	2,836	2,859	-

Total	$ 6,291	$ 2,963	$ 6,502	$ 15,756	$ 407,153	$ 422,909	$ -

The following table is an analysis of past due loans as of December 31, 2014:

	30-59 Days Past Due	60-89 Days Past Due	Greater Than 90 Days	Total Past Due	Current	Total Financing Receivables	Recorded Investment > 90 Days and Accruing

Real Estate Secured
Residential 1-4 family	$ 4,521	$ 3,001	$ 2,884	$ 10,406	$ 176,423	$ 186,829	$ -
Equity lines of credit	45	-	-	45	6,454	6,499	-
Multifamily	1,252	-	-	1,252	19,879	21,131	-
Farmland	208	-	477	685	7,561	8,246	-
Construction, Land Development, Other Land Loans	417	31	168	616	17,902	18,518	-
Commercial Real Estate- Owner Occupied	2,193	790	2,344	5,327	65,421	70,748	-
Commercial Real Estate- Non Owner Occupied	225	85	1,547	1,857	30,316	32,173	-
Second Mortgages	107	51	134	292	7,783	8,075	-
Non Real Estate Secured
Personal	404	105	233	742	20,444	21,186	22
Commercial	720	49	447	1,216	30,370	31,586	-
Agricultural	3	-	-	3	2,680	2,683	-

Total	$ 10,095	$ 4,112	$ 8,234	$ 22,441	$ 385,233	$ 407,674	$ 22

Notes to Consolidated Financial Statements

(Unaudited)

(in thousands, except share, per share and percentage data)

Loans are considered delinquent when payments have not been made according to the terms of the contract. The accrual of interest on loans is discontinued at the time the loan is 90 days delinquent unless the credit is well-secured and in process of collection. Credit card loans and other personal loans are typically charged off no later than 180 days past due. In all cases, loans are placed on non-accrual or charged-off at an earlier date if collection of principal or interest is considered doubtful.

The following is a summary of non-accrual loans at September 30, 2015 and December 31, 2014

	September 30, 2015	December 31, 2014
Real Estate Secured
Residential 1-4 Family	$ 2,201	$ 3,401
Multifamily	-	-
Construction and Land Loans	72	168
Commercial-Owner Occupied	3,683	5,259
Commercial- Non Owner Occupied	-	1,547
Second Mortgages	75	134
Equity Lines of Credit	-	-
Farmland	57	477
Secured (other) and Unsecured
Personal	115	211
Commercial	299	447
Agricultural	-	-

Total	$ 6,502	$ 11,644

The following is a summary of residential real estate currently in the process of foreclosure as well as foreclosed residential real estate as of September 30, 2015.

	Number	Balance
Residential real estate in the process of foreclosure	3	$ 257
Foreclosed residential real estate	10	$ 1,370

Notes to Consolidated Financial Statements

(Unaudited)

(in thousands, except share, per share and percentage data)

The following tables represent a summary of credit quality indicators of the Company’s loan portfolio at September 30, 2015 and December 31, 2014. The grades are assigned and/or modified by the Company’s credit review and credit analysis departments based on the creditworthiness of the borrower and the overall strength of the loan.

Credit Risk Profile by Internally Assigned Grade as of September 30, 2015

Grade (1)	Residential 1-4 Family	Multifamily	Farmland	Construction, Land Loans	Commercial Real Estate- Owner Occupied	Commercial Real Estate Non-Owner Occupied

Quality	27,011	-	27	2,393	2,737	516
Satisfactory	109,220	19,773	6,480	7,585	35,269	16,757
Acceptable	46,093	2,303	3,993	5,531	20,601	12,093
Special Mention	3,094	801	196	459	3,111	2,533
Substandard	8,994	1,123	826	1,868	7,672	1,895
Doubtful	-	-	-	-	-	-

Total	$ 194,412	$ 24,000	$ 11,522	$ 17,836	$ 69,390	$ 33,794

Credit Risk Profile by Internally Assigned Grade as of December 31, 2014

Grade (1)	Residential 1-4 Family	Multifamily	Farmland	Construction, Land Loans	Commercial Real Estate- Owner Occupied	Commercial Real Estate Non-Owner Occupied

Quality	29,494	6	37	3,278	4,159	874
Satisfactory	100,767	16,326	3,090	8,091	31,018	15,052
Acceptable	44,021	2,719	4,080	4,745	20,987	12,223
Special Mention	2,640	828	198	2,231	3,994	2,108
Substandard	9,907	1,252	841	173	10,590	1,916
Doubtful	-	-	-	-	-	-

Total	$ 186,829	$ 21,131	$ 8,246	$ 18,518	$ 70,748	$ 32,173

(1) Quality--This grade is reserved for the Bank’s top quality loans. These loans have excellent sources of repayment, with no significant identifiable risk of collection. Generally, loans assigned this rating will demonstrate the following characteristics:

·	Conformity in all respects with Bank policy, guidelines, underwriting standards, and Federal and State regulations (no exceptions of any kind).

·	Documented historical cash flow that meets or exceeds required minimum Bank guidelines, or that can be supplemented with verifiable cash flow from other sources.

·	Adequate secondary sources to liquidate the debt, including combinations of liquidity, liquidation of collateral, or liquidation value to the net worth of the borrower or guarantor.

For existing loans, all of the requirements above apply plus all payments have been made as agreed, current financial information on all borrowers and guarantors has been obtained and analyzed, and overall business operating trends are either stable or improving.

Satisfactory-This grade is given to performing loans. These loans have adequate sources of repayment, with little identifiable risk of collection. Loans assigned this rating will demonstrate the following characteristics:

·	General conformity to the Bank's policy requirements, product guidelines and underwriting standards. Any exceptions that are identified during the underwriting and approval process have been adequately mitigated by other factors.

·	Documented historical cash flow that meets or exceeds required minimum Bank guidelines, or that can be supplemented with verifiable cash flow from other sources.

Notes to Consolidated Financial Statements

(Unaudited)

(in thousands, except share, per share and percentage data)

·	Adequate secondary sources to liquidate the debt, including combinations of liquidity, liquidation of collateral, or liquidation value to the net worth of the borrower or guarantor

For existing loans, all of the requirements outlined above will apply, plus all payments have been made as agreed, current financial information on all borrowers and guarantors has been obtained and analyzed, and overall business operating trends are stable with any declines considered minor and temporary.

Acceptable-This grade is given to loans that show signs of weakness in either adequate sources of repayment or collateral, but have demonstrated mitigating factors that minimize the risk of delinquency or loss. Loans assigned this rating may demonstrate some or all of the following characteristics:

·	Additional exceptions to the Bank's policy requirements, product guidelines or underwriting standards that present a higher degree of risk to the Bank. Although the combination and/or severity of identified exceptions is greater, all exceptions have been properly mitigated by other factors.

·	Unproved, insufficient or marginal primary sources of repayment that appear sufficient to service the debt at this time. Repayment weaknesses may be due to minor operational issues, financial trends, or reliance on projected (not historic) performance.

·	Marginal or unproven secondary sources to liquidate the debt, including combinations of liquidation of collateral and liquidation value to the net worth of the borrower or guarantor.

For existing loans, payments have generally been made as agreed with only minor and isolated delinquencies.

Special Mention -This grade is given to Watch List loans that include the following characteristics:

·	Loans with underwriting guideline tolerances and/or exceptions with no identifiable mitigating factors.

·	Extending loans that are currently performing satisfactorily but with potential weaknesses that may, if not corrected, weaken the asset or inadequately protect the Bank's position at some future date. Potential weaknesses are the result of deviations from prudent lending practices.

·	Loans where adverse economic conditions that develop subsequent to the loan origination do not jeopardize liquidation of the debt, but do substantially increase the level of risk may also warrant this rating.

Substandard-Loans in this category are characterized by deterioration in quality exhibited by any number of well-defined weaknesses requiring corrective action. A substandard loan is inadequately protected by the current sound net worth and paying capacity of the obligor or of the collateral pledged, if any. Loans classified as substandard must have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt; they are characterized by the distinct possibility that the institution will sustain some loss if the deficiencies are not corrected.

The weaknesses may include, but are not limited to:

·	High debt to worth ratios and or declining or negative earnings trends;

·	Declining or inadequate liquidity;

·	Improper loan structure or questionable repayment sources;

·	Lack of well-defined secondary repayment source; and,

·	Unfavorable competitive comparisons.

Such loans are no longer considered to be adequately protected due to the borrower's declining net worth, lack of earnings capacity, declining collateral margins and/or unperfected collateral positions. A possibility of loss of a portion of the loan balance cannot be ruled out. The repayment ability of the borrower is marginal or weak and the loan may have exhibited excessive overdue status or extensions and/or renewals.

Notes to Consolidated Financial Statements

(Unaudited)

(in thousands, except share, per share and percentage data)

Doubtful -Loans classified Doubtful have all the weaknesses inherent in loans classified Substandard, plus the added characteristic that the weaknesses make collection or liquidation in full on the basis of currently existing facts, conditions, and values highly questionable and improbable. The ability of the borrower to service the debt is extremely weak, overdue status is constant, the debt has been placed on non-accrual status, and no definite repayment schedule exists.

However, these loans are not yet rated as loss because certain events may occur which would salvage the debt. Among these events are:

·	Injection of capital;

·	Alternative financing; and/or,

·	Liquidation of assets or the pledging of additional collateral.

Credit Risk Profile based on payment activity as of September 30, 2015

	Consumer - Non Real Estate	Equity Line of Credit / Second Mortgages	Commercial - Non Real Estate	Agricultural - Non Real Estate

Performing	$ 21,033	$ 14,039	$ 33,535	$ 2,859
Nonperforming (>90 days past due)	115	75	299	-

Total	$ 21,148	$ 14,114	$ 33,834	$ 2,859

Credit Risk Profile based on payment activity as of December 31, 2014

	Consumer - Non Real Estate	Equity Line of Credit /Second Mortgages	Commercial - Non Real Estate	Agricultural - Non Real Estate

Performing	$ 20,953	$ 14,440	$ 31,139	$ 2,683
Nonperforming (>90 days past due)	233	134	447	-

Total	$ 21,186	$ 14,574	$ 31,586	$ 2,683

Notes to Consolidated Financial Statements

(Unaudited)

(in thousands, except share, per share and percentage data)

The following tables reflect the Bank’s impaired loans at September 30, 2015:

September 30, 2015	Recorded Investment	Unpaid Principal Balance	Related Allowance	Average Recorded Investment	Interest Income Recognized
With No Related Allowance
Real Estate Secured
Residential 1-4 family	$ 6,714	$ 6,714	$ -	$ 7,351	$ 205
Equity lines of credit	50	50	-	37	2
Multifamily	1,123	1,123	-	1,188	46
Farmland	826	826	-	834	40
Construction, Land Development, Other Land Loans	1,556	1,556	-	1,647	68
Commercial Real Estate- Owner Occupied	7,672	7,672	-	8,430	121
Commercial Real Estate- Non Owner Occupied	-	-	-	-	-
Second Mortgages	217	217	-	418	8
Non Real Estate Secured
Personal /Consumer	70	70	-	62	4
Commercial	353	353	-	357	7
Agricultural	-	-	-	-	-

Total	$ 18,581	$ 18,581	$ -	$ 20,324	$ 501

September 30, 2015	Recorded Investment	Unpaid Principal Balance	Related Allowance	Average Recorded Investment	Interest Income Recognized
With an Allowance Recorded
Real Estate Secured
Residential 1-4 family	$ 2,472	$ 2,472	$ 405	$ 2,810	$ 78
Equity lines of credit	-	-	-	-	-
Multifamily	-	-	-	-	-
Farmland	-	-	-	-	-
Construction, Land Development, Other Land Loans	446	446	31	406	18
Commercial Real Estate- Owner Occupied	-	-	-	702	-
Commercial Real Estate- Non Owner Occupied	1,895	1,895	300	1,906	39
Second Mortgages	37	37	29	19	2
Non Real Estate Secured
Personal /Consumer	107	107	69	180	4
Commercial	681	681	525	742	25
Agricultural	-	-	-	4	-

Total	$ 5,638	$ 5,638	$ 1,359	$ 6,769	$ 166

Notes to Consolidated Financial Statements

(Unaudited)

(in thousands, except share, per share and percentage data)

The following tables reflect the Bank’s impaired loans at December 31, 2014:

December 31, 2014	Recorded Investment	Unpaid Principal Balance	Related Allowance	Average Recorded Investment	Interest Income Recognized
With no Related Allowance
Real Estate Secured
Residential 1-4 family	$ 7,988	$ 7,988	$ -	$ 7,015	$ 256
Equity lines of credit	24	24	-	194	1
Multifamily	1,252	1,252	-	626	21
Farmland	842	842	-	663	32
Construction, Land Development, Other Land Loans	1,738	1,738	-	1,716	64
Commercial Real Estate- Owner Occupied	9,188	9,392	-	7,291	262
Commercial Real Estate- Non Owner Occupied	-	-	-	3,227	-
Second Mortgages	618	618	-	340	20
Non Real Estate Secured
Personal	54	54	-	53	3
Commercial	361	361	-	229	20
Agricultural	-	-	-	-	-

Total	$ 22,065	$ 22,269	$ -	$ 21,354	$ 679

December 31, 2014	Recorded Investment	Unpaid Principal Balance	Related Allowance	Average Recorded Investment	Interest Income Recognized
With an Allowance Recorded
Real Estate Secured
Residential 1-4 family	$ 3,148	$ 3,148	$ 586	$ 3,087	$ 125
Equity lines of credit	-	-	-	19	-
Multifamily	-	-	-	-	-
Farmland	-	-	-	100	-
Construction, Land Development, Other Land Loans	366	366	20	183	13
Commercial Real Estate- Owner Occupied	1,403	1,403	143	2,466	56
Commercial Real Estate- Non Owner Occupied	1,916	1,916	322	3,249	31
Second Mortgages	-	-	-	28	-
Non Real Estate Secured
Personal	253	253	188	193	7
Commercial	802	802	540	863	28
Agricultural	7	7	7	94	1

Total	$ 7,895	$ 7,895	$ 1,806	$ 10,282	$ 261

Notes to Consolidated Financial Statements

(Unaudited)

(in thousands, except share, per share and percentage data)

The following tables present the balance in the allowance for loan losses and the recorded investment in loans by loan category and is segregated by impairment

evaluation method as of September 30, 2015 and September 30, 2014.

Nine months ended September 30, 2015	Residential 1-4 Family				Multi- family			Construction and Land Loans			Commercial R./E Owner Occupied			Commercial R/E Non-Owner Occupied			Second Mortgages		Equity Line of Credit			Farmland			Personal & Overdrafts		Commercial & Agricultural			Un- allocated		Total
Allowance for Credit Losses:
Beginning Balance December 31, 2014	$	995			$	20		$	87		$	409		$	1,063		$	67	$	74		$	12		$	665	$	982		$	1,103	$	5,477
Provision for Credit Losses		(159	)			(20	)		(70	)		(164	)		(259	)		9		(90	)		(4	)		649		130			675		697
Charge-offs		105		��		-			-			12			407			3		-			-			634		205			-		1,366
Recoveries		(1	)			-			(34	)		(6	)		(376	)		-		(41	)		(2	)		(59		(7	)		-		(526	)
Net Charge-offs		104				-			(34	)		6			31			3		(41	)		(2	)		575		198			-		841
Ending Balance September 30, 2015		732				-			51			239			773			73		25			10			739		914			1,777		5,333
Ending Balance: Individually evaluated for impairment		405				-			31			-			300			29		-			-			69		525			-		1,359
Ending Balance: Collectively Evaluated for Impairment		327				-			20			239			473			44		25			10			670		389			1,777		3,974
Loans:
Ending Balance: Individually Evaluated for Impairment		9,186				1,123			2,002			7,672			1,895			254		50			826			177		1,034			-		24,219
Ending Balance: Collectively Evaluated for Impairment		185,226				22,877			15,834			61,718			31,899			7,757		6,053			10,696			20,971		35,659			-		398,690
Ending Balance: September 30, 2015	$	194,412			$	24,000		$	17,836		$	69,390		$	33,794		$	8,011	$	6,103		$	11,522		$	21,148	$	36,693			-	$	422,909

Notes to Consolidated Financial Statements

(Unaudited)

(in thousands, except share, per share and percentage data)

Nine months ended Sept. 30, 2014	Residential 1-4 Family			Multi- family			Construction and Land Loans			Commercial R./E Owner Occupied			Commercial R/E Non-Owner Occupied		Second Mortgages			Equity Line of Credit		Farmland			Personal and Overdrafts			Commercial and Agricultural			Un- allocated			Total
Allowance for Credit Losses:
Beginning Balance December 31, 2013	$	975		$	143		$	230		$	1,029		$	1,415	$	153		$	50	$	65		$	483		$	1,264		$	1,018		$	6,825
Provision for Credit Losses		353			(102	)		(103	)		(218	)		982		(52	)		125		(51	)		599			23			(308	)		1,248
Charge-offs		188			-			18			345			1,239		25			100		-			471			387			-			2,773
Recoveries		(1	)		-			(6	)		(132	)		-		-			-		-			(54	)		(36	)		-			(229	)
Net Charge-offs		187			-			12			213			1,239		25			100		-			417			351			-			2,544
Ending Balance Sept. 30, 2014		1,141			41			115			598			1,158		76			75		14			665			936			710			5,529
Ending Balance: Individually evaluated for impairment		686			-			20			273			323		-			-		-			158			422			-			1,882
Ending Balance: Collectively Evaluated for Impairment		455			41			95			325			835		76			75		14			507			514			710			3,647
Loans:
Ending Balance: Individually Evaluated for Impairment		10,567			1,252			2,092			11,463			1,918		204			301		971			294			1,531			-			30,593
Ending Balance: Collectively Evaluated for Impairment		173,733			19,981			16,526			59,382			29,808		7,370			6,719		7,785			20,300			33,027			-			374,631
Ending Balance: Sept. 30, 2014	$	184,300		$	21,233		$	18,618		$	70,845		$	31,726	$	7,574		$	7,020	$	8,756		$	20,594		$	34,558		$	-		$	405,224

Notes to Consolidated Financial Statements

(Unaudited)

(in thousands, except share, per share and percentage data)

A loan is considered impaired and an allowance for loan losses is established on loans for which it is probable that the full collection of principal and interest is in doubt. Once a loan is identified as individually impaired, management measures impairment using one of several methods, including collateral value based on recent appraisal and /or tax assessment value, liquidation value and/or discounted cash flows. Those impaired loans not requiring an allowance represent loans for which the fair value of the expected repayments or collateral exceed the recorded investments in such loans. At September 30, 2015 and December 31, 2014, all of the total impaired loans were evaluated based on the fair value of the collateral. On a quarterly basis, the ALLL methodology begins with the determination of individually impaired loans. All loans that are rated “7” (Doubtful) are assessed as impaired based on the expectation that the full collection of principal and interest is in doubt. All loans that are rated “6” (Substandard) or are expected to be downgraded to “6”, require additional analysis to determine whether they may be impaired. All loans that are rated “5” (Special Mention) are presumed not to be impaired. However, “5” rated loans with the following characteristics warrant further analysis before completing an assessment of impairment:

•	A loan is 60 days or more delinquent on scheduled principal or interest;

•	A loan is presently in an unapproved over advanced position;

•	A loan is newly modified; or

•	A loan is expected to be modified.

The Company’s credit administration personnel and senior financial officers are responsible for tracking, coding, and monitoring loans that become Troubled Debt Restructurings (“TDRs”). Concessions are made to existing borrowers in the form of modified interest rates and / or payment terms. The loans are segregated for regulatory and external reporting. Each specific TDR is reviewed to determine if the accrual of interest should be discontinued and also reviewed for impairment. The Company’s senior credit administration officer performs this analysis on a quarterly basis in addition to determining any other loans that are impaired within the loan portfolio. The Company had a total of $9,381 and $12,060 of loans categorized as troubled debt restructurings as of September 30, 2015 and December 31, 2014, respectively. Interest is accrued on TDRs if the loan is otherwise not impaired and the full collection of principal and interest under the modified terms is still deemed probable.

In the determination of the allowance for loan losses, management considers troubled debt restructurings and subsequent defaults in these restructurings by adjusting the loan grades of such loans. Defaults resulting in charge-offs affect the historical loss experience ratios which are a component of the allowance calculation. Additionally, specific reserves may be established on restructured loans evaluated individually.

The following tables summarize the troubled debt restructurings during the nine months ended September 30, 2015 and 2014.

Notes to Consolidated Financial Statements

(Unaudited)

(in thousands, except share, per share and percentage data)

Troubled Debt Restructurings –Nine months ended September 30, 2015 Interest only	Number of Contracts	Pre- Modification Outstanding Recorded Investment	Post - Modification Recorded Investment
Real Estate Secured
Residential 1-4 family	1	188	188
Equity lines of credit
Multifamily
Farmland
Construction, Land Development, Other Land Loans
Commercial Real Estate- Owner Occupied	2	2,203	2,203
Commercial Real Estate- Non Owner Occupied
Second Mortgages	1	68	68
Non Real Estate Secured
Personal / Consumer
Commercial
Agricultural

Total	4	2,459	2,459

Troubled Debt Restructurings Below Market Rate	Number of Contracts	Pre- Modification Outstanding Recorded Investment	Post - Modification Recorded Investment
Real Estate Secured
Residential 1-4 family	1	863	863
Equity lines of credit
Multifamily
Farmland
Construction, Land Development, Other Land Loans
Commercial Real Estate- Owner Occupied	1	1,547	1,547
Commercial Real Estate- Non Owner Occupied
Second Mortgages
Non Real Estate Secured
Personal / Consumer
Commercial
Agricultural

Total	2	2,410	2,410

Notes to Consolidated Financial Statements

(Unaudited)

(in thousands, except share, per share and percentage data)

Troubled Debt Restructurings Loan term extension	Number of Contracts	Pre- Modification Outstanding Recorded Investment	Post - Modification Recorded Investment
Real Estate Secured
Residential 1-4 family	1	131	131
Equity lines of credit
Multifamily
Farmland
Construction, Land Development, Other Land Loans	1	35	35
Commercial Real Estate- Owner Occupied
Commercial Real Estate- Non Owner Occupied
Second Mortgages
Non Real Estate Secured
Personal / Consumer
Business Commercial
Agricultural

Total	2	166	166
Troubled Debt Restructurings All	Number of Contracts	Pre- Modification Outstanding Recorded Investment	Post - Modification Recorded Investment
Total Restructurings	8	5,035	5,035

Troubled Debt Restructurings That subsequently defaulted	Number of Contracts	Pre- Modification Outstanding Recorded Investment	Post - Modification Recorded Investment
Real Estate Secured
Residential 1-4 family
Equity lines of credit
Multifamily
Farmland
Construction, Land Development, Other Land Loans
Commercial Real Estate- Owner Occupied
Commercial Real Estate- Non Owner Occupied
Second Mortgages
Non Real Estate Secured
Personal / Consumer
Commercial
Agricultural

Total	-	-	-

Notes to Consolidated Financial Statements

(Unaudited)

(in thousands, except share, per share and percentage data)

Troubled Debt Restructurings –Nine months ended September 30, 2014 Interest only	Number of Contracts	Pre- Modification Outstanding Recorded Investment	Post - Modification Recorded Investment
Real Estate Secured
Residential 1-4 family
Equity lines of credit
Multifamily	1	1,252	1,252
Farmland
Construction, Land Development, Other Land Loans
Commercial Real Estate- Owner Occupied	1	1,395	1,395
Commercial Real Estate- Non Owner Occupied
Second Mortgages
Non Real Estate Secured
Personal / Consumer
Commercial
Agricultural

Total	2	2,647	2,647

Troubled Debt Restructurings Below Market Rate	Number of Contracts	Pre- Modification Outstanding Recorded Investment	Post - Modification Recorded Investment
Real Estate Secured
Residential 1-4 family	1	879	879
Equity lines of credit
Multifamily
Farmland
Construction, Land Development, Other Land Loans
Commercial Real Estate- Owner Occupied	1	707	707
Commercial Real Estate- Non Owner Occupied
Second Mortgages
Non Real Estate Secured
Personal / Consumer
Commercial
Agricultural

Total	2	1,586	1,586

Notes to Consolidated Financial Statements

(Unaudited)

(in thousands, except share, per share and percentage data)

Troubled Debt Restructurings Loan term extension	Number of Contracts	Pre- Modification Outstanding Recorded Investment	Post - Modification Recorded Investment
Real Estate Secured
Residential 1-4 family	6	1,217	1,217
Equity lines of credit
Multifamily
Farmland
Construction, Land Development, Other Land Loans
Commercial Real Estate- Owner Occupied	1	2,114	2,114
Commercial Real Estate- Non Owner Occupied
Second Mortgages
Non Real Estate Secured
Personal / Consumer
Business Commercial
Agricultural	1	129	129

Total	8	3,460	3,460
	Number of Contracts	Pre- Modification Outstanding Recorded Investment	Post - Modification Recorded Investment
Total Restructurings	12	7,693	7,693

Troubled Debt Restructurings That subsequently defaulted	Number of Contracts	Pre- Modification Outstanding Recorded Investment	Post - Modification Recorded Investment
Real Estate Secured
Residential 1-4 family
Equity lines of credit
Multifamily
Farmland
Construction, Land Development, Other Land Loans
Commercial Real Estate- Owner Occupied
Commercial Real Estate- Non Owner Occupied
Second Mortgages
Non Real Estate Secured
Personal / Consumer
Commercial
Agricultural

Total	-	-	-

Notes to Consolidated Financial Statements

(Unaudited)

(in thousands, except share, per share and percentage data)

The loan review function performs various tasks that are utilized to discover weaknesses within the loan portfolio. These include annual reviews on loan relationships that are greater than $500. The relationship review includes a discussion on the collateral, repayment history, guarantor(s) financial position, and debt service coverage on an individual and global level. These reviews are based primarily upon federal tax returns for cash flow determination, internally prepared interim statements and personal financial statements. Debt service coverage (DSC) is calculated on each individual customer, or guarantor, as well as the aggregate or global DSC. The DSC is discounted to determine a “stressed” DSC. Collateral evaluation includes an inspection of the collateral file to determine if the Bank is indeed properly securitized. Collateral is discounted, when appropriate, to determine a “stressed” loan to value (LTV) ratio. In addition to annual loan relationship reviews, quarterly reviews on all loan relationships over $100 that are graded Substandard, Doubtful and Loss are also completed. This quarterly review process is comprised of a shortened version of the full relationship review. These quarterly reviews include a discussion on personal credit management, DSC and LTV. In addition to these quarterly reviews of non-pass watch list relationships, a semi-annual review is conducted on all Special Mention loan relationships that are on the watch list. These reviews are prepared in the same manner as the quarterly non-pass relationship reviews. The appropriateness of the risk rating of each relationship is assessed, with changes to the risk rating being made by the Senior Credit Review Officer, when deemed appropriate. Other measures taken to determine potential problem relationships include the monthly preparation of the watch list. During that process, past due loan reports are reviewed, as well as any other information that might be presented by loan officers, regarding a particular loan relationship that is exhibiting stress. To be considered as a watch list relationship, distinct characteristics must be exhibited. These include, but are not limited to late payments greater than 60 days, a low DSC calculation, bankruptcy filings, casualty losses, or other issues that would cause a perceived increase in the risk of loss to the Bank. The final segment of the loan review process involves special reviews. These reviews target specific segments of the loan portfolio, i.e. credit cards, equity lines, consumer loans, construction loans, and other specific segments of the loan portfolio that management wishes to have reviewed. However, currently, the primary emphasis of the loan review function is loan relationship review work, and watch list management.

The segments of the Company’s loan portfolio are disaggregated to a level that allows management to monitor risk and performance. In reviewing risk, management has determined there to be several different risk categories within the loan portfolio. The allowance for loan losses consists of amounts applicable to: (i) the commercial loan portfolio; (ii) the commercial real estate loan portfolio; (iii) the construction loan portfolio; (iv) the consumer loan portfolio; and, (v) the residential loan portfolio. The commercial real estate (“CRE”) loan segment is further disaggregated into two classes. Non-owner occupied CRE loans, which include loans secured by non-owner occupied nonfarm nonresidential properties, generally have a greater risk profile than all other CRE loans, which include multifamily structures and owner-occupied commercial structures. The construction loan segment is further disaggregated into two classes. One-to-four family residential construction loans are generally made to individuals for the acquisition of and/or construction on a lot or lots on which a residential dwelling is to be built. Commercial construction loans are generally made to developers or investors for the purpose of acquiring, developing and constructing residential or commercial structures. Construction lending is generally considered to involve a higher degree of credit risk than long-term permanent financing.

The following describes the Company’s basic methodology for computing its ALLL.

On a quarterly basis, the ALLL methodology begins with the identification of loans subject to ASC 310. All loans that are rated “7” (Doubtful) are assessed as impaired based on the expectation that the full collection of principal and interest is in doubt. All loans that are rated “6” (Substandard) or are expected to be downgraded to “6”, require additional analysis to determine whether they may be impaired under ASC 310. All loans that are rated “5” (Special Mention) are presumed not to be impaired. However, “5” rated loans, together with any Troubled Debt Restructured (TDR) loan, may warrant further analysis before completing an assessment of impairment.

For ASC 310 loans that are individually evaluated and found to be impaired (primarily those designated as Substandard and Doubtful), the associated ALLL will be based upon one of the three impairment measurement methods specified within ASC 310:

(1)	Present value of expected future cash flows discounted at the loan’s effective interest rate;

(2)	Loan’s observable market price; or

(3)	Fair value of the collateral.

Notes to Consolidated Financial Statements

(Unaudited)

(in thousands, except share, per share and percentage data)

To determine the amount of loan loss exposure for the impaired ASC 310 loans, the value of collateral for secured loans is evaluated to determine the current value and potential exposure. The collateral value is adjusted for its age and condition, and, for real estate, adjusted for condition, location, and age of the most current appraisal. If the adjusted value of the collateral is less than the current principal balance, the difference is designated as direct exposure for loan loss calculations. The total balance of unsecured loans is considered as direct exposure.

ASC 450 Loan Loss:

For all other loans, including individual loans determined not to be impaired under ASC 310, the associated ALLL is calculated in accordance with ASC 450 that provides for estimated credit losses likely to be realized on groups of loans with similar risk characteristics. The Company uses standard call report categories to segregate loans into groups with similar risk characteristics. Estimated credit losses reflect significant factors that affect the collectability of the portfolio as of the evaluation date. Key factors that influence risk within the Company’s loan portfolio are divided into three major categories:

(1) Historical Loss Factor: To calculate the anticipated loan loss in each call report category for ASC 450 loans, the Company begins with the net loss in each category for each of the last twelve quarters. The Company uses a rolling twelve quarter weighted historical loss average where the most recent quarters are weighted heavier than the earlier quarters so that the calculation reflects current risk trends within the portfolio. The weighting used by the Company is similar to the Rule of 78’s with the net losses of the most recent quarter weighted at 12/78ths and those in the first quarter in the twelve quarter period weighted at 1/78th. Therefore, the net losses of the most recent year represent approximately 54% of the calculation compared with 33% if a simple average of losses over the three-year period was used. The total of weighted factors for each call report category is applied to the current outstanding loan balance in each category to calculate expected loss based on historical data for a group of loans with similar risk characteristics. The same weighting is applied to all loan types.

(2)External economic factors: Economic conditions have a significant impact on Company’s loan portfolio because deteriorating conditions can adversely impact both collateral values and the customer’s ability to service debt. Management has selected the following external factors as indicators of economic conditions:

a.	National GDP Growth Rate

b.	Local Unemployment Rates

c.	The Prime Rate

The values for external factors are updated on a quarterly basis based on current economic data.

(3)Internal process factors: Internal factors that influence loss rates as a result of risk management and control practices include the following:

d.	Past-Due Loans

e.	Non-Accrual Loans

f.	CRE Concentrations

g.	Loan Volume Level

h.	Level and Trend of Classified Loans

The values for internal factors are updated on a quarterly basis based on current portfolio metrics.

Once the quarterly ALLL is computed, the calculations are reviewed by the Company’s credit administration committee which is comprised of the CEO, CFO, and Senior Lending Officers, including Credit Review personnel. The Company’s controller also performs a detailed review of the computations, estimates, etc. included in the ALLL calculation. The ALLL is then reviewed and approved by the Board of Directors.

Notes to Consolidated Financial Statements

(Unaudited)

(in thousands, except share, per share and percentage data)

Note 3 - Income Taxes

Income tax expense (benefit) for the nine months ended September 30 is different than the amount computed by applying the statutory corporate federal income tax rate of 34% to income before taxes. The reasons for these differences are as follows:

	2015	2014

Tax expense at statutory rate	$ 475	$ 323
Reduction in taxes from:
Tax-exempt interest	(95)	(126)
Valuation adjustment for deferred tax assets	(1,000)	(1,000)
Life Insurance proceeds	-	(44)
Other, net	(126)	(136)
Income tax benefit	$ (746)	$ (983)

In the second quarter of 2015, the Company reversed the remaining balance of the valuation allowance that was established against the deferred tax assets (“DTA”) during the fourth quarter of 2011. The valuation allowance was established during 2011 due to uncertainty at the time regarding the ability to generate sufficient future taxable income to fully realize the benefit of the net DTA. Subsequent to 2011, earnings performance and asset quality have improved resulting in greater expected realization of the DTA. In addition, the Company raised $16,123 in net proceeds of new capital in 2014 which allowed the Company to pay off two high rate debt instruments (the Company’s Community Bankers Bank note and Trust Preferred Securities) improving future earnings potential. As a result of these factors, the Company reversed $1,000 of the DTA in the second quarter of 2014, and due to the continued improvements in asset quality and earnings performance the remaining $1,000 of the DTA valuation allowance was reversed in the second quarter of 2015. In assessing the realizability of DTA, management considers whether it is more likely than not that some portion or all of the DTA will not be realized. The Company evaluates the carrying amount of its DTA on a quarterly basis in accordance with the guidance provided in FASB ASC Topic 740 (“ASC 740”), in particular, applying the criteria set forth therein to determine whether it is more likely than not (i.e., a likelihood of more than 50%) that some portion, or all, of the DTA will not be realized within its life cycle, based on the weight of available evidence. In most cases, the realization of the DTA is dependent upon the Company generating a sufficient level of taxable income in future periods, which can be difficult to predict. If the Company’s forecast of taxable income within the carry forward periods available under applicable law is not sufficient to cover the amount of net deferred assets, such assets may be impaired. Management considers the reversal of deferred tax liabilities (including the impact of available carry-back and carry-forward periods), projected future taxable income and tax-planning strategies in making this assessment.

Note 4 - Capital Requirements

Regulators of the Company and its subsidiary, Highlands Union Bank (the “Bank”), have implemented risk-based capital guidelines which require compliance with certain minimum capital ratios as a percent of assets and other certain off-balance sheet items that are adjusted for predefined credit risk factors. On July 7, 2013 the Federal Reserve Board approved Basel III Final Rules to begin implementation January 1, 2015. The desired overall objective of Basel III is to improve the banking sector’s ability to absorb shocks arising from financial and economic stress by requiring banks to maintain higher levels of common equity and regulatory capital. The Final Rule includes a new Common Equity Tier 1 (CET1) minimum ratio and raises the Tier 1 Risk Weighted Assets ratio to 6% from 4%. In addition, the new rules increase the risk weighting of various assets and require a bank to maintain a capital conservation buffer of 2½%. The new rules were effective January 1, 2015 with phase in of the conservation buffer to begin in 2016 with full compliance by 2019.

Notes to Consolidated Financial Statements

(Unaudited)

(in thousands, except share, per share and percentage data)

On December 18, 2014, the President of the United States signed into law Public Law 113-250 (the “Act”), which directs the Board of Governors of the Federal Reserve System (Board) to propose revisions to the Small Bank Holding Company Policy Statement (Policy Statement) to raise the total consolidated asset threshold in the Policy Statement from $500 million to $1 billion. On February 5, 2015 the Company received notification from the Federal Reserve Bank that it would no longer be required to report holding company consolidated capital ratios. The following tables present the capital ratios for the Bank only.

September 30, 2015
Entity	Tier 1	Total Risk Based	Leverage	CET 1
				Effective in 2015
Highlands Union Bank	11.71%	12.98%	7.42%	11.71%

December 31, 2014
Entity	Tier 1	Total Risk Based	Leverage	CET 1


Highlands Union Bank	12.93%	14.19%	7.71%	N/A

Note 5. Private Placement Capital Raise / Rights Offering

On April 16, 2014, management and board of directors of Highlands Bankshares, Inc. announced the completion of a $16,525 private placement capital raise. Purchasers in the private placement included outside investors, as well as certain directors and executive officers of the Company. The Company sold 2,673,249 newly issued shares of the Company’s common stock at $3.50 per share, and 2,048,179 shares of Series-A convertible perpetual preferred stock at $3.50 per share. The private placement was disclosed on Form 8-K on April 16, 2014. The Company immediately paid off a Holding Company Loan in the amount of $3,440 to Community Bankers Bank on April 16, 2014 with the funds received from the capital raise. The Company also paid off the remaining $3,150 of its trust preferred securities including accrued interest. The payoff totaling $4,802 was completed on July 15, 2014. The Company down-streamed to the subsidiary Bank in June 2014 $7,500 of funds received from the capital raise. During the third quarter of 2014, the Company also conducted a rights offering to its existing shareholders other than directors and executive officers. The Company raised a total of $556 as a result of the offering. The Company immediately down-streamed $400 of the $556 to the Bank in September of 2014. In October 2014, one of the private placement purchasers, TNH Financial Fund, LP, purchased another $183 of common and preferred stock which allowed them to maintain the same ownership percentage that was held immediately prior to the rights offering. Net proceeds received from the private placement issues and rights offering totaled $16,123.

Notes to Consolidated Financial Statements

(Unaudited)

(in thousands, except share, per share and percentage data)

Note 6 – Per Share Amounts

Earnings per common share is computed using the weighted average outstanding shares for the three and nine months ended September 30, 2015 and 2014. Outstanding stock options impact on earnings per share is determined using the treasury stock method. For 2015 and 2014, the impact of conversions of outstanding stock options was anti-dilutive. During 2014, the Company issued a total of 2,092,287 shares of Series A preferred stock (See Note 5). These preferred shares are non-voting mandatorily convertible non-cumulative preferred shares which are entitled to receive dividends equal to dividends paid on the Company’s common shares. The Series A preferred shares will rank pari passu with the common stock with respect to all terms (other than voting), including, the payment of dividends or distributions, and payments and rights upon liquidation and dissolution. The following is a reconciliation of the numerators and the denominators of the basic and diluted earnings per common share computation:

For the three months ended September 30	2015	2014

Income available to common stockholders	$ 429	$ 526
Weighted average shares outstanding	7,851	7,712
Shares outstanding including assumed conversion	9,943	9,760
Basic earnings per common share	$ 0.05	$ 0.07
Fully diluted earnings per share (including convertible preferred shares outstanding)	$ 0.04	$ 0.05

For the nine months ended September 30	2015	2014

Income available to common stockholders	$ 2,143	$ 1,933
Weighted average shares outstanding	7,851	6,666
Shares outstanding including assumed conversion	9,943	8,714
Basic earnings per common share	$ 0.27	$ 0.29
Fully diluted earnings per share (including convertible preferred shares outstanding)	$ 0.22	$ 0.22

Note 7 – Commitments and Contingencies

The Bank is a party to various financial instruments with off-balance sheet risk arising in the normal course of business to meet the financing needs of its customers. Those financial instruments include commitments to extend credit and standby letters of credit. At September 30, 2015, these commitments included: standby letters of credit of $332; equity lines of credit of $7,772; credit card lines of credit of $6,369 commercial real estate, construction and land development commitments of $3,720; and other unused commitments to fund interest earning assets of $31,673.

Notes to Consolidated Financial Statements

(Unaudited)

(in thousands, except share, per share and percentage data)

Note 8 – Fair Value

The Company utilizes fair value measurements to record fair value adjustments to certain assets and to determine fair value disclosures. Securities available-for-sale are recorded at fair value on a recurring basis. Additionally, from time to time, the Company may be required to record at fair value other assets on a nonrecurring basis. These nonrecurring fair value adjustments typically involve application of lower of cost or market accounting or write-downs of individual assets.

Fair Value Hierarchy

Under ASC Topic 820 on Fair Value Measurements and Disclosures, the Company groups assets and liabilities at fair value in three levels, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value. These levels are:

	Level 1		Valuation is based upon quoted prices for identical instruments traded in active markets.

	Level 2		Valuation is based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques for which all significant assumptions are observable in the market.

	Level 3		Valuation is generated from model-based techniques that use at least one significant assumption not observable in the market. These unobservable assumptions reflect estimates of assumptions that market participants would use in pricing the asset or liability. Valuation techniques include use of option pricing models, discounted cash flow models and similar techniques.

In general, fair value is based upon quoted market prices, where available. If such quoted market prices are not available, fair value is based upon third party models that primarily use, as inputs, observable market-based parameters. Valuation adjustments may be made to ensure that financial instruments are recorded at fair value. These adjustments may include amounts to reflect counterparty credit quality, the Company’s creditworthiness, among other things, as well as unobservable parameters. Any such valuation adjustments are applied consistently over time. The Company’s valuation methodologies may produce a fair value calculation that may not be indicative of net realizable value or reflective of future fair values. While management believes the Company’s valuation methodologies are appropriate and consistent with other market participants, the use of different methodologies or assumptions to determine the fair value of certain financial instruments could result in a different estimate of fair value at the reporting date.

Notes to Consolidated Financial Statements

(Unaudited)

(in thousands, except share, per share and percentage data)

Recurring - Investment Securities Available for Sale

Securities classified as available for sale are reported at fair value utilizing Level 2. For Level 2 securities, the Company obtains fair value measurements from multiple independent third party sources. The fair value measurements consider observable data that may include dealer quotes, market spreads, cash flows, the U.S. Treasury yield curve, live trading levels, trade execution data, market consensus prepayment speeds, credit information, and the bond’s terms and conditions, among other things.

The following tables summarize the Company’s available for sale securities portfolio measured at fair value on a recurring basis as of September 30, 2015 and December 31, 2014, segregated by the level of the valuation inputs within the fair value hierarchy.

September 30, 2015
	Level 1		Level 2		Level 3		Total Fair Value
Available for Sale Securities
State and Political Subdivisions	$	-	$	6,973	$	-	$	6,973
Mortgage Backed Securities		-		66,624		-		66,624
Single Issue Trust Preferred		-		-		-		-
SBA Pools		-		10,867		-		10,867
Total AFS Securities	$	-	$	84,464	$	-	$	84,464

December 31, 2014
	Level 1		Level 2		Level 3		Total Fair Value
Available for Sale Securities
State and Political Subdivisions	$	-	$	9,701	$	-	$	9,701
Mortgage Backed Securities		-		61,723		-		61,723
Single Issue Trust Preferred		-		488		-		488
SBA Pools		-		12,423		-		12,423
Total AFS Securities	$	-	$	84,335	$	-	$	84,335

Notes to Consolidated Financial Statements

(Unaudited)

(in thousands, except share, per share and percentage data)

Non Recurring - Loans

The Company does not record loans at fair value on a recurring basis. However, from time to time, a loan is considered impaired and an allowance for loan losses is established. Loans for which it is probable that payment of interest and principal will not be made in accordance with the contractual terms of the loan agreement are considered impaired. Once a loan is identified as individually impaired, management measures impairment using one of several methods, including recently appraised collateral value and /or tax assessed value, liquidation value and discounted cash flows. Those impaired loans not requiring an allowance represent loans for which the fair value of the expected repayments or collateral exceed the recorded investments in such loans. At September 30, 2015 and December 31, 2014, all of the total impaired loans were evaluated based on the fair value of the collateral. The Company frequently obtains appraisals prepared by external professional appraisers and applies discounts ranging from 8% to 50% depending on type of property, condition, location, etc. which the Company considers to be nonrecurring Level 3. The Company also, in certain instances, prepares internally generated valuations from on-site inspections, third-party valuation models or other information.

Non Recurring -Foreclosed Assets / Repossessions

Foreclosed assets and repossessions are adjusted to fair value upon transfer of the loans to foreclosed assets and repossessions. Subsequently, foreclosed assets and repossessions are carried at the lower of carrying value or fair value. Fair value is based upon independent market prices or recent appraised values of the collateral, which the Company considers to be nonrecurring Level 2. When the current appraised value is not available and /or further discounted below the most recent appraised value less selling costs due to such things as absorption rates and market conditions, the Company classifies the foreclosed assets within Level 3 of the fair value hierarchy.

The following table summarizes the Company’s assets at fair value on a non - recurring basis as of September 30, 2015 and December 31, 2014 segregated by the level of the valuation inputs within the fair value hierarchy. The tables disclose the recorded investment of impaired loans requiring a specific allowance.

September 30, 2015	Level 1		Level 2		Level 3		Total Fair Value
Impaired Loans	$	-	$	-	$	5,638	$	5,638
Repossessions/OREO, net	$	-	$	-	$	7,305	$	7,305


December 31, 2014	Level 1		Level 2		Level 3		Total Fair Value
Impaired Loans	$	-	$	-	$	7,895	$	7,895
Repossessions/OREO, net	$	-	$	-	$	6,704	$	6,704

Notes to Consolidated Financial Statements

(Unaudited)

(in thousands, except share, per share and percentage data)

The following table presents additional quantitative information about assets measured at fair value on a nonrecurring basis for which the Company uses Level 3 inputs to determine fair value (dollars in thousands):

Quantitative Information about Level 3 Fair Value Measurements

September 30,

December 31,

Valuation

Unobservable

Range

2015

2014

Techniques

Input (2)

(Weighted Average)

OREO,Repossessions

7,305

6,704

Appraisal of collateral (1)

Appraisal adjustments

0% to 45% (13%)

Liquidation expenses

0% to 10% (9%)

Impaired loans

5,638

7,895

Fair value of collateral –real estate (1), (3)

Appraisal adjustments

0% to 10% (9%)

Fair value of collateral –equipment, inventory, other (1), (3)

Appraisal adjustments

25% to 50% (33%)

Liquidation expenses

0% to 10% (9%)

Valuation adjustments and liquidation cost adjustments represent unobservable inputs for OREO and impaired loans. The ranges of discounts applied are based on age of independent appraisals, type and condition of collateral, current market conditions, and experience with the local market.

	(1)	Fair value is generally determined through independent appraisals of the underlying collateral, which generally include various Level 3 inputs which are not identifiable.
	(2)	Appraisals may be adjusted by management for qualitative factors such as economic conditions and estimated liquidation expenses. The range and weighted average of liquidation expenses and other appraisal adjustments are presented as a percent of the appraisal.
	(3)	Includes qualitative adjustments by management.

Notes to Consolidated Financial Statements

(Unaudited)

(in thousands, except share, per share and percentage data)

General

The Company has no liabilities carried at fair value or measured at fair value on a recurring or non-recurring basis.

Fair Value of Financial Instruments

Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Fair value is best determined based upon quoted market prices. However, in many instances, there are no quoted market prices for the Company’s various financial instruments. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. Accordingly, the fair value estimates may not be realized in an immediate settlement. Accordingly, the aggregate fair value amounts presented may not necessarily represent the underlying fair value of the Company.

Cash and Cash Equivalents

The carrying amount reported in the balance sheets for cash, short-term investments and federal funds sold approximates fair value.

Securities Available for Sale

Fair values are determined in the manner as described above.

Other Investments

Other investments include Federal Home Loan Bank stock, Federal Reserve Bank stock, Community Bankers Bank stock, and Pacific Coast Bankers Bank. The carrying value of those securities approximates fair value based on the redemption provisions of those Banks. Also included in other investments are certificates of deposit purchased from other FDIC insured banks in which the carrying amount approximates fair value.

Loans

The fair value of loans represents the amount at which the loans of the Bank could be exchanged on the open market, based upon the current lending rate for similar types of lending arrangements discounted over the remaining life of the loans. For fixed rate loans and for variable rate loans with infrequent re-pricing or re-pricing limits, fair value is based on discounted cash flows using current market rates applied to the cash flow analysis.

Deposits

The fair value of time deposits is based on discounted cash flows using current market rates applied to the cash flow analysis for each time deposit. Other non-maturity deposits are reported at their carrying values.

Other Short-Term Borrowings

Fair values of other short-term borrowings are estimated using discounted cash flow analyses based on the Company’s current incremental borrowing rates for similar types of borrowing arrangements. Estimated maturity dates are also included in the calculation of fair value for these borrowings.

Notes to Consolidated Financial Statements

(Unaudited)

(in thousands, except share, per share and percentage data)

Long-term Debt

Rates currently available to the Company for debt with similar terms and remaining maturities or established call prices are used to estimate fair value of existing debt.

Off-Balance Sheet Instruments

The amount of off-balance sheet commitments to extend credit, standby letters of credit, and financial guarantees, is considered equal to fair value. Because of the uncertainty involved in attempting to assess the likelihood and timing of commitments being drawn upon, coupled with the lack of an established market and the wide diversity of fee structures, the Company does not believe it is meaningful to provide an estimate of fair value that differs from the given value of the commitment.

The carrying amounts and fair values of the Company's financial instruments at September 30, 2015 and December 31, 2014 were as follows:

	September 30, 2015		December 31, 2014
	Carrying Amount	Fair Value	Carrying Amount	Fair Value
	Carrying Amount	Fair Value	Carrying Amount	Fair Value

Cash and cash equivalents	$ 48,813	$ 48,813	$ 55,810	$ 55,810
Securities available for sale	84,464	84,464	84,335	84,335
Other investments	6,599	6,599	6,767	6,767
Loans, net	416,813	411,382	401,520	398,019
Deposits	(491,369)	(474,751)	(483,497)	(464,335)
Other short-term borrowings	(20,051)	(21,231)	(20,051)	(21,495)
Long-term debt	(47,712)	(51,050)	(47,750)	(50,799)

Notes to Consolidated Financial Statements

(Unaudited)

(in thousands, except share, per share and percentage data)

Note 9 -Investment Securities Available For Sale

The amortized cost and market value of securities available for sale are as follows:

	September 30, 2015
	Amortized Cost	Gross Unrealized Gains	Gross Unrealized Losses	Fair Value
	Amortized Cost	Gross Unrealized Gains	Gross Unrealized Losses	Fair Value

State and political subdivisions	$ 6,843	$ 130	$ -	$ 6,973
Mortgage backed securities	66,444	342	162	66,624
Single Issue Trust Preferred	-	-	-	-
SBA Pools	10,980	16	129	10,867
	$ 84,267	$ 488	$ 291	$ 84,464

	December 31, 2014
	Amortized Cost	Gross Unrealized Gains	Gross Unrealized Losses	Fair Value
	Amortized Cost	Gross Unrealized Gains	Gross Unrealized Losses	Fair Value

State and political subdivisions	$ 9,546	$ 163	$ 8	$ 9,701
Mortgage backed securities	61,476	395	148	61,723
Single Issue Trust Preferred	500	-	12	488
SBA Pools	12,669	29	275	12,423
	$ 84,191	$ 587	$ 443	$ 84,335

Investment securities available for sale with an amortized cost of $32,868 and $39,298 at September 30, 2015 and December 31, 2014, respectively, and a market value of $32,975 and $39,325 at September 30, 2015 and December 31, 2014, respectively, were pledged as collateral on public deposits, FHLB advances and for other purposes as required or permitted by law.

Notes to Consolidated Financial Statements

(Unaudited)

(in thousands, except share, per share and percentage data)

The following table presents the age of gross unrealized losses and fair value by investment category:

	September 30, 2015
	Less Than 12 months				12 Months or More				Total
	Fair Value		Unrealized Losses		Fair Value		Unrealized Losses		Fair Value		Unrealized Losses

State and political subdivisions	$	-	$	-	$	-	$	-	$	-	$	-
Mortgage-backed securities		24,387		78		4,858		84		29,245		162
Single Issue Trust Preferred		-		-		-		-		-		-
SBA Pools		7		-		9,653		129		9,660		129

Total	$	24,394	$	78	$	14,511	$	213	$	38,905	$	291

	December 31, 2014
	Less Than 12 months				12 Months or More				Total
	Fair Value		Unrealized Losses		Fair Value		Unrealized Losses		Fair Value		Unrealized Losses

State and political subdivisions	$	-	$	-	$	1,002	$	8	$	1,002	$	8
Mortgage-backed securities		5,244		19		7,586		129		12,830		148
Single Issue Trust Preferred		-		-		488		12		488		12
SBA Pools		-		-		11,239		275		11,239		275

Total	$	5,244	$	19	$	20,315	$	424	$	25,559	$	443

The Company assesses its securities for “OTTI” (other than temporary impairment) quarterly by reviewing credit ratings, financial and regulatory reports as well as other pertinent published financial data. As of September 30, 2015 and December 31, 2014, the Company's assessment revealed no impairment other than that deemed temporary on those securities.

The amortized cost and estimated fair value of securities available for sale at September 30, 2015 by contractual maturity are shown below. Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.

	Amortized Cost	Approximate Market Value
	Amortized Cost	Approximate Market Value
Due in one year or less	$ -	$ -
Due after one year through five years	2,638	2,689
Due after five years through ten years	7	7
Due after ten years	15,178	15,144
	17,823	17,840

Mortgage-backed securities	66,444	66,624
	$ 84,267	$ 84,464

Notes to Consolidated Financial Statements

(Unaudited)

(in thousands, except share, per share and percentage data)

Note 10–Formal Written Agreement

On October 13, 2010, the Company and Bank entered into a written agreement (“Written Agreement”) with the Federal Reserve Bank of Richmond (the “Reserve Bank”). Under the terms of the Written Agreement, the Bank has agreed to develop and submit to the Reserve Bank for approval within the time periods specified therein written plans or programs to:

·	strengthen board oversight of the management and operations of the Bank;

·	strengthen credit risk management and administration;

·	provide for the effective grading of the Bank’s loan portfolio;

·	summarize the findings of its review of the adequacy of the staffing of its loan review function;

·	improve the Bank’s position with respect to loans, relationships, or other assets in excess of $500 that currently are or in the future become past due more than 90 days, on the Bank’s problem loan list, or adversely classified in any report of examination of the Bank;

·	review and revise the Bank’s methodology for determining the allowance for loan and lease losses (“ALLL”) and maintain an adequate ALLL;

·	maintain sufficient capital at the Company and the Bank;

·	establish a revised written contingency funding plan;

·	establish a revised written strategic and capital plan;

·	establish a revised investment policy;

·	improve the Bank’s earnings and overall condition;

·	revise the Bank’s information technology program;

·	establish a disaster recovery and business continuity program; and,

·	establish a committee to monitor compliance with all aspects of the written agreement.

Further, both the Company and the Bank have agreed to refrain from declaring or paying dividends without prior regulatory approval. The Company has agreed that it will not take any other form of payment representing a reduction in Bank’s capital or make any distributions of interest, principal or other sums on subordinated debentures or trust preferred securities without prior regulatory approval. The Company also has agreed not to incur, increase or guarantee any debt or not to purchase or redeem any shares of its stock without prior regulatory approval.

Notes to Consolidated Financial Statements

(Unaudited)

(in thousands, except share, per share and percentage data)

Note 11 – Summary of Significant Accounting Policy Update For Certain Required Disclosures

Accounting Standards Update (ASU) No. 2014-04, Receivables - Troubled Debt Restructurings by Creditors - Reclassification of Residential Real Estate Collateralized Consumer Mortgage Loans upon Foreclosure was issued by the FASB on January 20, 2014. The amendments are intended to clarify when a creditor should be considered to have received physical possession of residential real estate property collateralizing a consumer mortgage loan such that the loan should be derecognized and the real estate recognized. These amendments clarify that an in substance repossession or foreclosure occurs, and a creditor is considered to have received physical possession of residential real estate property collateralizing a consumer mortgage loan, upon either: (a) the creditor obtaining legal title to the residential real estate property upon completion of a foreclosure; or (b) the borrower conveying all interest in the residential real estate property to the creditor to satisfy that loan through completion of a deed in lieu of foreclosure or through a similar legal agreement. Additional disclosures are required. The amendment was effective for the current reporting period. The adoption of this ASU did not have a material impact on the Company’s consolidated financial statements.

On May 28, 2014, the FASB issued ASU 2014-09 – Revenue from Contracts with Customers, which requires an entity to recognize the amount of revenue to which it expects to be entitled for the transfer of promised goods or services to customers. The ASU will replace most existing revenue recognition guidance in U.S. GAAP when it becomes effective. The core principle of the new guidance is that entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. To achieve the core principle, an entity should apply the following steps: (1) identify the contract with the customer, (2) identify the performance obligations in the contract, (3) determine the transaction price, (4) allocate the transaction price to the performance obligations in the contract, and (5) recognize revenue when the performance obligation is satisfied. The new guidance was originally effective for the Company for annual reporting periods beginning after December 15, 2016, including interim periods within that reporting period, early application is not permitted. On July 9, 2015, the FASB approved a one-year deferral of the effective date of the update. The update is effective for interim and annual reporting periods in fiscal years beginning after December 15, 2017. Early adoption is now permitted as of the original effective date for interim and annual reporting periods in fiscal years beginning after December 15, 2016. The Company is evaluating the effect that ASU 2014-09 will have on its consolidated financial statements and related disclosures; however, the Company does not currently expect the new guidance to have a material effect on its financial statements.

Other accounting standards have been issued by the FASB that are not currently applicable to the Company or are not expected to have a material impact on the Company’s financial statements

ITEM 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis is provided to address information about the Company’s financial condition and results of operations that is not otherwise apparent from the Consolidated Financial Statements and the notes thereto or included in this report. Reference should be made to those statements and the notes thereto for an understanding of the following discussion and analysis.

The Company generates a significant amount of its income from the net interest income earned by the Bank. Net interest income is the difference between interest income and interest expense. Interest income depends on the amount of interest-earning assets outstanding during the period and the interest rates earned thereon. The Company’s cost of money is a function of the average amount of deposits and borrowed money outstanding during the period and the interest rates paid thereon. The quality of the assets further influences the amount of interest income lost on non-accrual loans and the amount of additions to the allowance for loan losses. Highlands Union Insurance Services and Highlands Union Financial Services, which are subsidiaries of Highlands Union Bank, generate fee income by providing insurance and financial service products to its clients. Blue Ridge Hospitality, LLC and Russell Road Properties, LLC are also entities in which the Bank has a significant interest and were created to hold and manage certain properties acquired by the Bank through foreclosure or deed in lieu of foreclosure.

Critical Accounting Policy

The financial condition and results of operations presented in the Consolidated Financial Statements, accompanying Notes to Consolidated Financial Statements and management’s discussion and analysis are, to a large degree, dependent upon the accounting policies of the Company. The selection and application of these accounting policies involve judgments, estimates, and uncertainties that are susceptible to change. For a discussion of the Company’s critical accounting policies related to its allowance for loan losses and other than temporary impairment, see the Company’s Annual Report on Form 10-K for the year ended December 31, 2014.

Formal Written Agreement

As discussed in Note 10, on October 13, 2010, the Company and Bank entered into a written agreement (“Written Agreement”) with the Federal Reserve Bank of Richmond (the “Reserve Bank”). Under the terms of the Written Agreement, the Bank has agreed to develop and submit to the Reserve Bank for approval within the time periods specified therein written plans or programs to:

·	strengthen board oversight of the management and operations of the Bank;

·	strengthen credit risk management and administration;

·	provide for the effective grading of the Bank’s loan portfolio;

·	summarize the findings of its review of the adequacy of the staffing of its loan review function;

·	improve the Bank’s position with respect to loans, relationships, or other assets in excess of $500,000 that currently are or in the future become past due more than 90 days, on the Bank’s problem loan list, or adversely classified in any report of examination of the Bank;

·	review and revise the Bank’s methodology for determining the allowance for loan and lease losses (“ALLL”) and maintain an adequate ALLL;

·	maintain sufficient capital at the Company and the Bank;

·	establish a revised written contingency funding plan;

·	establish a revised written strategic and capital plan;

·	establish a revised investment policy;

·	improve the Bank’s earnings and overall condition;

·	revise the Bank’s information technology program;

·	establish a disaster recovery and business continuity program; and,

·	establish a committee to monitor compliance with all aspects of the written agreement.

Further, both the Company and the Bank have agreed to refrain from declaring or paying dividends without prior regulatory approval. The Company has agreed that it will not take any other form of payment representing a reduction in the Bank’s capital or make any distributions of interest, principal or other sums on subordinated debentures or trust preferred securities without prior regulatory approval. The Company also has agreed not to incur, increase or guarantee any debt or not to purchase or redeem any shares of its stock without prior regulatory approval.

The following summarizes the Company’s progress to comply with the items in the Written Agreement as of September 30, 2015:

·	A new board oversight policy has been approved and implemented;

·	Completed revising the Bank’s loan grading system and ALLL methodology;

·	Implemented Problem Loan Action reports and Problem Asset reports for all assets over $500,000;

·	Completed revising the written contingency funding plan;

·	Implemented stress testing of the loan portfolio;

·	Completed revising the investment policy;

·	Completed a Business Continuity Plan and Disaster Recovery Plan; and,

·	Formed a Directors’ compliance committee to monitor the progress of each item in the written agreement. The committee meets at least quarterly and files a report with the Federal Reserve Bank.

Results of Operations

Results of operations for the three-month and nine-month periods ended September 30, 2015 reflect earnings of $429 thousand and $2.14 million, respectively, compared to $526 thousand and $1.93 million for the corresponding periods in 2014.

Net interest income for the three-month period ended September 30, 2015 decreased $53 thousand or 1.13% compared to the three months ended September 30, 2014. For the nine-month period ended September 30, 2015 net interest income increased $508 thousand or 3.80% as compared to the nine month period ended September 30, 2014. Average interest-earning assets increased $2.63 million from the nine month period ended September 30, 2014 to the current nine month period, while average interest-bearing liabilities decreased $8.79 million over the same period. The tax-equivalent yield on average interest-earning assets was 4.30% for the nine month period ended September 30, 2015 representing an decrease of 10 basis points from the same period in 2014. The rate on average interest-bearing liabilities decreased 15 basis points to 1.05% for the nine month period ended September 30, 2015 as compared to 1.20% for the same period in 2014.

Total interest income for the three and nine months ended September 30, 2015 was $161 thousand and $66 thousand less than the comparable 2014 periods due primarily to lower average yields on loans and securities for 2015 compared to the prior period. Average loan balances for the nine month period ended September 30, 2015 increased approximately $7.56 million over the same period in 2014. The average balance of federal funds sold was $34.24 million during the nine month period ended September 30, 2015 compared to $64.01 million for the previous year. The average yield on federal funds sold was .25% during the period.

The Company’s total interest expense decreased by $108 thousand for the three months and $574 thousand for the nine months from the same periods in 2014, due in part to the overall reduction in time deposit balances and the 2014 payoffs of the Community Bankers Bank Holding Company Loan and Trust Preferred Securities. Also new interest-bearing time deposits are continuing to be recorded at lower rates and existing interest-bearing time deposits and other liabilities are re-pricing lower as they renew.

During the first nine months of 2015, the Company’s non-interest income decreased by $314 thousand over the corresponding period for 2014. Total non-interest income for the three months ended September 30, 2015 decreased $102 thousand over the three month period ended September 30, 2014 due primarily to decreases in NSF (non- sufficient funds) fees.

Total non-interest expense for the nine month period ended September 30, 2015 increased $296 thousand as compared to the nine month period ended September 30, 2014. FDIC insurance premiums totaling $607 thousand for the nine months ended September 30, 2015 decreased $383 thousand from the same nine month period in 2014. Foreclosed asset expenses, write-downs and losses on the sale of foreclosed assets and repossessions in the amount of $684 thousand decreased $550 thousand for the nine month period ended September 30, 2015 as compared to the prior period. Other operating expenses increased $421 thousand for the nine months ended September 30, 2015 as compared to the nine months ended September 30, 2014 primarily as a result of a claims settlement as discussed below. Salaries and employee benefits increased $174 thousand for the nine months ended September 30, 2015 as compared to the prior year period primarily due to an increase in personnel. Furniture and equipment expense increased $164 thousand for the nine months ended September 30, 2015 compared to the prior period primarily due to increases in equipment maintenance and data connectivity costs. Total non-interest expense for the three month period ended September 30, 2015 increased $12 thousand compared to the three month period ended September 30, 2014.

In October 2015, the Bank settled claims in the Angela Welch matter for $425,000, of which $325,000 is reflected in other operating expenses during the third quarter of 2015. The Bank previously had accrued $100,000 for potential future legal fees in the first quarter of 2015. See “Item 1. Legal Proceedings” in Part II of this Form 10-Q for additional information regarding this matter.

In addition to FDIC insurance premiums, for the nine months ended September 30, 2015, other operating expenses that exceeded 1% of total interest income and other operating income were charges for other contracted services totaling $589 thousand, advertising costs totaling $229 thousand, software licensing and maintenance costs totaling $532 thousand, legal expenses totaling $230 thousand, other loan expenses totaling $256 thousand, bank franchise taxes totaling $271 thousand, other losses totaling $401 thousand and postage and freight expenses totaling $208 thousand.

In addition to FDIC insurance premiums, for the nine months ended September 30, 2014, other operating expenses that exceeded 1% of total interest income and other operating income were charges for other contracted services totaling $495 thousand, software licensing and maintenance costs totaling $478 thousand, legal expenses totaling $218 thousand, other loan expenses totaling $263 thousand, postage and freight expenses totaling $231 thousand, and bank franchise taxes totaling $185 thousand.

For the three month period ended September 30, 2015, other operating expenses that exceeded 1% of total interest income and other operating income were charges for FDIC insurance totaling $206 thousand, legal expenses totaling $90 thousand, other loan expense of $84 thousand, postage and freight expenses totaling $74 thousand, other contracted services totaling $203 thousand, software licensing and maintenance totaling $188 thousand, other losses totaling $362 thousand and bank franchise taxes totaling $96 thousand.

For the three month period ended September 30, 2014, other operating expenses that exceeded 1% of total interest income and other operating income were charges for FDIC insurance totaling $330 thousand, legal expenses totaling $68 thousand, other loan expense of $128 thousand, other contracted services totaling $159 thousand, software licensing and maintenance totaling $179 thousand, bank franchise taxes totaling $75 thousand and postage and freight expenses totaling $79 thousand.

Operating results of the Company when measured as a percentage of average equity reveals a decrease in return on average equity to 5.32% for the nine-month period ended September 30, 2015 from 5.83% for the corresponding period in 2014. Return on average assets for the nine months ended September 30, 2015 was 0.47% compared to 0.43% for the nine months ended September 30, 2014.The provision for loan losses for the three-month and nine-month periods ended September 30, 2015 totaled $215 thousand and $697 thousand, respectively, a $137 thousand decrease and $551 thousand decrease as compared to the corresponding periods in 2014. This decreased provision during the first nine months of 2015 as compared to the first nine months of 2014 was primarily due to one significant charge-off of approximately $1 million in the Company’s Knoxville, Tennessee market occurring in June of 2014. Net charge-offs (inclusive of recoveries) for the first nine months of 2015 were $840 thousand compared with $2.54 million for the first nine months of 2014. Year–to–date net charge-offs were 0.20% and 0.63% of total loans for the periods ended September 30, 2015 and September 30, 2014, respectively. The Company continually monitors the loan portfolio for signs of credit weaknesses or developing collection problems. Loan loss provisions for each period are determined after evaluating the loan portfolio and determining the level necessary to absorb current charge-offs and maintain the reserve at adequate levels. Loan loss reserves decreased 3.54% to $5.33 million at September 30, 2015 from $5.53 million at September 30, 2014. The Company’s allowance for loan loss reserves at September 30, 2015 decreased to 1.26% of total loans versus 1.37% at September 30, 2014. At December 31, 2014, the allowance for loan loss reserve as a percentage of total loans was 1.35%.

Management, in conjunction with the board of directors, will continue to evaluate the carrying value of the Company’s DTA on a quarterly basis, in accordance with ASC 740, and will determine any need for a future valuation allowance based upon circumstances and expectations then in existence.

Financial Position

Total loans, net of deferred fees, increased to $422.15 million at September 30, 2015 from $404.58 million at September 30, 2014. Total loans, net of fees, at December 31, 2014 were $406.99 million. The loan to deposit ratio increased to 85.91% at September 30, 2015 from 82.92% at September 30, 2014. The loan to deposit ratio at December 31, 2014 was 84.18%. Deposits at September 30, 2015 have increased $3.42 million since September 30, 2014 and have increased $7.87 million since December 31, 2014. During the last several years, the Company has continued to lower the interest rates paid on time deposits in a continuing effort to reduce its cost of funds.

The Company currently has approximately $67.76 million in outstanding FHLB advances. No new advances were originated during the last 12 months. The Company secures all of its existing and future advances from the FHLB with a selected group of in-house residential and commercial real estate secured loans and a selected group of securities that are held in safekeeping by the FHLB.

Non-performing assets are comprised of loans on non-accrual status, loans contractually past due 90 days or more and still accruing interest, other real estate owned and repossessions. Non-performing assets were $13.81 million or 2.24% of total assets at September 30, 2015, compared with $18.36 million or 3.04% of total assets at December 31, 2014 and $21.44 million or 3.52% of total assets at September 30, 2014. The Company continues to focus its efforts on reducing its NPAs, primarily by reducing non accrual loans and selling OREO property.

The adequacy of the allowance for loan losses is based on management's judgment and analysis of current and historical loss experience, risk characteristics of the loan portfolio, concentrations of credit and asset quality, as well as other internal and external factors, such as general economic conditions. The internal credit review department performs pre-approval analyses of large credits and also conducts credit review activities that provide management with an early warning of loan deterioration. The senior credit administration officer prepares quarterly analyses of the adequacy of the allowance for loan losses. These analyses include individual loans considered impaired for direct exposure. In addition, potential losses on loan pools and pool allocations are based upon historical losses and other factors, as adjusted, for various loan types. The calculation for allowance for loan losses is reviewed by both the Credit Administration Committee and the Board of Directors.

At September 30, 2015 and December 31, 2014, the internal credit review department as well as management determined that the Company's allowance for loan losses is sufficient and is appropriate based on the requirements of U.S. Generally Accepted Accounting Principles.

At September 30, 2015, OREO balances were $7.28 million and consisted of 30 accounts. At December 31, 2014 OREO balances were $6.68 million and consisted of 31 accounts. The following chart details each category type, number, and balance.

OREO Property at 9/30/15

OREO Description	Number	Balance at 9/30/15
		(in thousands)
Land Development - Vacant Land	11	$ 1,594
1-4 Family	10	1,370
Farmland	-	-
Commercial Real Estate	9	4,313

Total	30	$ 7,277

OREO Property at 12/31/2014

OREO Description	Number	Balance at 12/31/14
		(in thousands)
Land Development - Vacant Land	12	$ 1,723
1-4 Family	13	2,382
Farmland	-	-
Commercial Real Estate	6	2,580

Total	31	$ 6,685

The Company’s major markets are Southwestern Virginia, Tri-city Tennessee, Sevierville and Knoxville, Tennessee, Boone and Banner Elk, North Carolina.. The increase in OREO balances during the first nine months of 2015 is primarily due to two commercial properties totaling $2.06 million located in the Company’s Southwest Virginia market that were transferred out of non- accrual status into OREO. Both loans had been in non-accrual status for several previous quarters. The following table provides information about properties owned in each geographic area, the number of individual properties and book value.

	September 30, 2015		December 31, 2014

Geographic Area	Number	Value (in thousands)	Number	Value (in thousands)

Sevierville and Knoxville TN Area	6	$1,288	7	$2,041
Southwest VA and Tri-city TN Area	19	5,210	14	2,986
Boone and Banner Elk NC Area	5	779	10	1,658

Total	30	$7,277	31	$6,685

The Company formed a special assets committee to focus directly on selling OREO properties and reducing other non-performing assets. The committee is comprised of lending officers from all of the Bank’s market areas. The ability to sell OREO which has been negatively affected by the current economic climate and the resulting reduction of non-performing assets, will to a large degree, depend on how quickly specific market areas rebounds. Management has allocated significant resources to facilitate sales of OREO to reduce the Company’s non-performing assets. The Bank is actively marketing all of its property through its website, listing agents, and other marketing methods. The Bank conducted several on-site auctions during the month of July 2015 that resulted in contracts totaling $1.1 million. Of this $1.1 million of OREO sales, $588 thousand closed in the third quarter. The remaining $512 thousand closed between October 1, 2015 and November 3, 2015 and therefore is included in the Company’s September 30, 2015 OREO balance.

Investment securities and other investments totaled $91.06 million (market value) at September 30, 2015 which reflects a decrease of $39 thousand from the December 31, 2014 total of $91.10 million. Investment securities available for sale and other investments at September 30, 2015 were comprised of mortgage backed securities / CMOs (73.16% of the total securities portfolio), municipal issues (7.66%), and SBAs pools (11.93%). The Company’s entire securities portfolio was classified as available for sale at both September 30, 2015 and December 31, 2014.

Other investments include holdings of Federal Reserve, Federal Home Loan Bank, Pacific Coast Bankers Bank, and Community Bankers Bank stock. These investments (carrying value of $4.36 million) are considered to be restricted as the Company is required to hold these investments and the only market for these investments is the issuing agency. Also included in other investments are 9 certificates of deposit purchased from other FDIC insured institutions. The balance of these certificates of deposit totaled $2.24 million at September 30, 2015.

Liquidity and Capital Resources

Total stockholders’ equity of the Company was $54.75 million at September 30, 2015 representing an increase of $2.20 million or 4.19% from September 30, 2014. Total stockholders’ equity at December 31, 2014 was $52.80 million. The increase in stockholders’ equity from September 30, 2014 to September 30, 2015 is primarily due to the net earnings achieved over the last 12 months.

Quantitative measures established by regulation to ensure capital adequacy require the Bank to maintain minimum amounts and ratios of total risk-based capital to risk-weighted assets (as defined in the regulations), Tier I capital to risk-weighted assets (as defined in the regulations), Common Equity Tier 1 to risk-weighted assets (as defined in the regulations), and Tier I capital to adjusted total assets (as defined). See Note 4 for a more detailed discussion of the Bank’s regulatory capital ratios. The Board of Directors and management are committed to further increasing our capital levels and we are continuing to explore options to increase our capital.

Liquidity is the ability to provide sufficient cash levels to meet financial commitments and to fund loan demand and deposit withdrawals. The Company and subsidiary Bank maintain a significant level of liquidity in the form of cash and cash equivalents ($48.81 million as of September 30, 2015) and unrestricted investment securities available for sale ($51.49 million). Cash and cash equivalents are immediately available for satisfaction of deposit withdrawals, customer credit needs, and operations of the Bank. The Bank also maintains a significant amount of available credit with both the Federal Home Loan Bank and a correspondent financial institution. Unencumbered investment securities available for sale represent a secondary level of liquidity available for conversion to liquid funds in the event of extraordinary needs. As discussed in Note 5, the Company paid off its Holding Company Loan to Community Bankers Bank in April 2014, and its trust preferred securities and all related accrued interest in July 2014. The Company believes that it maintains sufficient liquidity to meet its current and projected requirements and needs.

Caution About Forward-Looking Statements

This quarterly report contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934, including certain plans, expectations, goals and projections, which are inherently subject to numerous assumptions, risks and uncertainties. The Company's actual results could differ materially from those set forth or implied in the forward-looking statements.

Such forward-looking statements involve known and unknown risks including, but not limited to, the following factors:

·	adverse economic conditions in the market area and the impact on credit quality and risks inherent in the loan portfolio such as repayment risk and fluctuating collateral values;

·	our inability to manage, dispose of and properly value non-performing assets and other real estate owned;

·	further deterioration in the housing market and collateral values;

·	our inability to assess the creditworthiness of our loan portfolio and maintain a sufficient allowance for loan losses;

·	our inability to maintain adequate sources of funding and liquidity, including secondary sources such as Federal Home Loan Bank advances;

·	our ability to attract and maintain capital levels adequate to support our asset levels and risk profile;

·	our inability to comply with the written agreement, dated October 13, 2010, with the Federal Reserve Bank of Richmond;

·	our successful management of interest rate risk and changes in interest rates and interest rate policies;

·	reliance on our management team, including our ability to attract and retain key personnel;

·	our ability to successfully manage our strategic plan;

·	difficult market conditions in our industry;

·	problems with technology utilized by us;

·	our ability to successfully manage third-party vendors upon whom we are dependent;

·	competition with other banks and financial institutions, and companies outside of the banking industry, including those companies that have substantially greater access to capital and other resources;

·	potential impact on us of recently enacted legislation and future regulation;

·	changes in accounting policies or standards;

·	demand, development and acceptance of new products and services; and,

·	changing trends in customer profiles and behavior.

ITEM 3. Quantitative and Qualitative Disclosures About Market Risk

Not Applicable

ITEM 4. Controls and Procedures

We have carried out an evaluation, under the supervision and the participation of our management, including our Chief Executive Officer, Chief Financial Officer and Vice President of Accounting, of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a-15(e) under the Exchange Act) as of the end of the period covered by this report. Based upon that evaluation, our Chief Executive Officer, Chief Financial Officer and Vice President of Accounting concluded that our disclosure controls and procedures are effective in providing reasonable assurance that (a) the information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and (b) such information is accumulated and communicated to our management, including our Chief Executive Officer, Chief Financial Officer and Vice President of Accounting, as appropriate to allow timely decisions regarding required disclosure.

There have not been any changes in the Company’s internal controls over financial reporting during the third quarter of 2015 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II. OTHER INFORMATION

Item 1. Legal Proceedings

On January 27, 2014, Angela Welch, as Chapter 7 Trustee for the bankruptcy estate of Frank Michael Mongelluzzi, named the Bank as a defendant in a lawsuit filed in the U.S. District Court for the Middle District of Florida, Tampa Division. The complaint states three counts: the first for avoidance and recovery of fraudulent transfers pursuant to 11 U.S.C. § 544(b) and Florida Statutes §§ 726.105(1)(a) and 726.108, and/or otherwise applicable law; the second for avoidance and recovery of fraudulent transfers pursuant to 11 U.S.C. § 544(b) and Florida Statutes §§ 726.105(1)(b) and 726.108, and/or otherwise applicable law; and the third for avoidance and recovery of fraudulent transfers pursuant to 11 U.S.C. § 544(b) and Florida Statutes §§ 726.106(1) and 726.108, and/or otherwise applicable law. Each count seeks the recovery of $1,246,103 in overdraft repayments made by the debtor to the Bank, prejudgment interest, and costs. This matter was transferred to the U.S. District Court for the Western District of Virginia. In October 2015, the Bank settled these claims for $425,000, which settlement was approved by the U.S. Bankruptcy Court for the Middle District of Florida. In November 2015, the U.S. District Court for the Western District of Virginia entered an order dismissing these claims, with prejudice. The $425,000 payment is reflected in other losses (non-interest expense) for the nine months ended September 2015. $325,000 is reflected in other losses during the third quarter of 2015 due to $100,000 of the settlement previously being accrued for potential future legal fees in the first quarter of 2015 that was applied to the settlement.

Item 1A. Risk Factors

Not applicable

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

None

Item 3. Defaults Upon Senior Securities

None

Item 4. Mine Safety Disclosures

Not Applicable

Item 5. Other Information

None

Item 6. Exhibits

31.1	Rule 13a-14(a) Certification of Chief Executive Officer
31.2	Rule 13a-14(a) Certification of Chief Financial Officer
31.3	Rule 13a-14(a) Certification of Vice President of Accounting
32.1	Certification Statement of Chief Executive Officer pursuant to 18 U.S.C. Section 1350.
32.2	Certification Statement of Chief Financial Officer pursuant to 18 U.S.C. Section 1350
32.3	Certification Statement of Vice President of Accounting pursuant to 18 U.S.C. Section 1350
101	The following materials from the Registrant’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2015, formatted in Extensible Business Reporting Language (XBRL), include: (i) the Consolidated Balance Sheets, (ii) the Consolidated Statements of Income, (iii) the Consolidated Statements of Comprehensive Income, (iv) Consolidated Statements of Cash Flows; (v) Consolidated Statements of Changes in Stockholders' Equity and (vi) related notes (furnished herewith).

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

	HIGHLANDS BANKSHARES, INC.

	(Registrant)

November 13, 2015	/s/ Timothy K. Schools
	Timothy K. Schools
	President and Chief Executive Officer


November 13, 2015	/s/ Robert M. Little, Jr.
	Robert M. Little, Jr.
	Chief Financial Officer


November 13, 2015	/s/ James R. Edmondson
	James R. Edmondson
	Vice President - Accounting

Exhibit Index

31.1	Rule 13a-14(a) Certification of Chief Executive Officer
31.2	Rule 13a-14(a) Certification of Chief Financial Officer
31.3	Rule 13a-14(a) Certification of Vice President of Accounting
32.1	Certification Statement of Chief Executive Officer pursuant to 18 U.S.C. Section 1350.
32.2	Certification Statement of Chief Financial Officer pursuant to 18 U.S.C. Section 1350
32.3	Certifiction Statement of Vice President of Accounting pursuant to 18 U.S.C. Section 1350
101	The following materials from the Registrant’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2015, formatted in Extensible Business Reporting Language (XBRL), include: (i) the Consolidated Balance Sheets, (ii) the Consolidated Statements of Income, (iii) the Consolidated Statements of Comprehensive Income, (iv) Consolidated Statements of Cash Flows; (v) Consolidated Statements of Changes in Stockholders' Equity and (vi) related notes (furnished herewith).

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Highlands Bankshares Inactive 10-Q2015 Q4 Quarterly report

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