Highlands Bankshares (HBSI) 10-Q 2007 Q3 Quarterly report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

FORM 10-Q

(Mark One)

ý  QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2007

o  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission File Number:  0-16761

HIGHLANDS BANKSHARES, INC.

(Exact name of registrant as specified in its charter)

West Virginia	55-0650793
(State or Other Jurisdiction of	(IRS Employer
Incorporation or Organization)	Identification No.)

P.O. Box 929

Petersburg, WV 26847

(Address of Principal Executive Offices, Including Zip Code)

304-257-4111

(Registrant’s Telephone Number, Including Area Code)

Indicate by check mark whether the registrant (1) filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the past 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 ý No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filed, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check One):

Large Accelerated Filer o Accelerated Filer o Non Accelerated filer ý

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

Indicate the number of shares outstanding of each of the issuer’s classes of common stock as of the latest practicable date. As of October 31, 2007:  1,436,874 shares of Common Stock, $5 Par Value

HIGHLANDS BANKSHARES, INC.
Quarterly Report on Form 10Q For The Period Ended September 30,2007
	INDEX
		Page
PART I	FINANCIAL INFORMATION
Item 1.	Financial Statements
	Unaudited Consolidated Statements of Income
	Nine Months Ended September 30, 2007 and 2006	2
	Unaudited Consolidated Statements of Income
	Three Months Ended September 30, 2007 and 2006	3
	Unaudited Consolidated Balance Sheet for September 30, 2007
	And Audited Consolidated Balance Sheet for December 31, 2006	4
	Unaudited Consolidated Statements of Changes in Stockholders’
	Equity for the Nine Months Ended September 30, 2007 and 2006	5
	Unaudited Consolidated Statements of Cash Flows for the Nine
	Months Ended September 30, 2007 and 2006	6
	Notes to Consolidated Financial Statements	7
Item 2.	Management’ Discussion and Analysis of Financial Condition
	And Results of Operations	10
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	20
Item 4.	Controls and Procedures	20
Item 4T.	Controls and Procedures	21
PART II	OTHER INFORMATION
Item 1.	Legal Proceedings	21
Item 1A.	Risk Factors	21
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	21
Item 3.	Defaults Upon Senior Securities	21
Item 4.	Submission of Matters to a Vote of Security Holders	21
Item 5.	Other Information	21
Item 6.	Exhibits	21
SIGNATURES		22

Item 1. Financial Statements

Page Two

HIGHLANDS BANKSHARES, INC.
CONSOLIDATED STATEMENTS OF INCOME
(In Thousands of Dollars, Except Per Share Data)
	Nine Months Ended September 30,
	2007		2006
	(unaudited)		(unaudited)
Interest Income
Interest and fees on loans	$	18,830	$	16,149
Interest on federal funds sold		600		338
Interest on deposits in other banks		100		39
Interest and dividends on securities		1,033		891
Total Interest Income		20,563		17,417
Interest Expense
Interest on deposits		7,458		5,043
Interest on borrowed money		447		529
Total Interest Expense		7,905		5,572
Net Interest Income		12,658		11,845
Provision for Loan Losses		486		508
Net Interest Income After Provision for Loan Losses		12,172		11,337
Noninterest Income
Service Charges		979		892
Investment in insurance contracts		173		321
Other noninterest income		355		323
Total Noninterest Income		1,507		1,536
Noninterest Expense
Salaries and employee benefits		4,467		4,224
Equipment and occupancy expense		1,043		984
Data processing expense		649		580
Directors fees		283		297
Legal and professional fees		430		365
Other noninterest expense		1,445		1,304
Total Noninterest Expense		8,317		7,754
Income Before Provision For Income Taxes		5,362		5,119
Provision for Income Taxes		1,985		1,758
Net Income	$	3,377	$	3,361
Per Share Data
Net Income	$	2.35	$	2.34
Cash Dividends	$	.75	$	.69
Weighted Average Common Shares Outstanding		1,436,874		1,436,874
The accompanying notes are an integral part of these statements.

Page Three

HIGHLANDS BANKSHARES, INC.
CONSOLIDATED STATEMENTS OF INCOME
(In Thousands of Dollars, Except Per Share Data)
	Three Months Ended September 30,
	2007		2006
	(unaudited)		(unaudited)
Interest Income
Interest and fees on loans	$	6,471	$	5,699
Interest on federal funds sold		195		124
Interest on deposits in other banks		30		17
Interest and dividends on securities		383		302
Total Interest Income		7,079		6,142
Interest Expense
Interest on deposits		2,652		1,873
Interest on borrowed money		144		175
Total Interest Expense		2,796		2,048
Net Interest Income		4,283		4,094
Provision for Loan Losses		145		155
Net Interest Income After Provision for Loan Losses		4,138		3,939
Noninterest Income
Service Charges		347		316
Investment in insurance contracts		57		37
Other noninterest income		138		129
Total Noninterest Income		542		482
Noninterest Expense
Salaries and employee benefits		1,504		1,442
Equipment and occupancy expense		352		335
Data processing expense		221		208
Directors fees		100		100
Legal and professional fees		153		127
Other noninterest expense		527		419
Total Noninterest Expense		2,857		2,631
Income Before Provision For Income Taxes		1,823		1,790
Provision for Income Taxes		690		634
Net Income	$	1,133	$	1,156
Per Share Data
Net Income	$	.79	$	.80
Cash Dividends	$	.25	$	.23
Weighted Average Common Shares Outstanding		1,436,874		1,436,874
The accompanying notes are an integral part of these statements.

Page Four

HIGHLANDS BANKSHARES, INC.
CONSOLIDATED BALANCE SHEETS
(In Thousands of Dollars)
	September 30, 2007			December 31, 2006
	(unaudited)			(audited)
ASSETS
Cash and due from banks—non-interest bearing		7,825		$	7,111
Deposits in other banks—interest bearing		3,383			1,624
Federal funds sold		12,552			12,210
Securities held to maturity		170			170
Securities available for sale, at market value		28,335			23,729
Restricted investments		1,499			1,570
Loans		308,035			292,816
Allowance for loan losses		(3,711	)		(3,482	)
Bank premises and equipment, net of depreciation		8,007			8,099
Interest receivable		2,534			2,173
Investment in life insurance contracts		6,239			6,066
Goodwill		1,534			1,534
Other intangible assets		1,366			1,498
Other Assets		2,629			2,198
Total Assets	$	380,397		$	357,316
LIABILITIES
Non-interest bearing deposits	$	46,990		$	46,726
Savings and interest bearing demand deposits		71,972			71,590
Time deposits		204,610			182,168
Total Deposits		323,572			300,484
Long term debt		12,265			14,992
Accrued expenses and other liabilities		5,090			4,764
Total Liabilities		340,927			320,240
STOCKHOLDERS’ EQUITY
Common Stock, $5 par value, 3,000,000 shares authorized, 1,436,874 shares issued and outstanding		7,184			7,184
Surplus		1,662			1,662
Retained Earnings		31,115			28,816
Other accumulated comprehensive loss		(491	)		(586	)
Total Stockholders’ Equity		39,470			37,076
Total Liabilities and Stockholders’ Equity	$	380,397		$	357,316
The accompanying notes are an integral part of these statements.

Page Five

HIGHLANDS BANKSHARES, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY
(In Thousands of Dollars)
	Common Stock		Surplus		Retained Earnings			Accumulated Other Comprehensive Income			Total
Balances at December 31, 2005	$	7,184	$	1,662	$	25,651		$	(505	)	$	33,992
Net Income						3,361						3,361
Net change in unrealized appreciation on investment securities available for sale, net of taxes									33			33
Total Comprehensive Income												3,394
Dividends Paid						(991	)					(991	)
Balances September 30, 2006	$	7,184	$	1,662	$	28,021		$	(472	)	$	36,395

	Common Stock		Surplus		Retained Earnings			Accumulated Other Comprehensive Income			Total
Balances at December 31, 2006	$	7,184	$	1,662	$	28,816		$	(586	)	$	37,076
Net Income						3,377						3,377
Net change in unrealized appreciation on investment securities available for sale, net of taxes									95			95
Total Comprehensive Income												3,472
Dividends Paid						(1,078	)					(1,078	)
Balances September 30, 2007	$	7,184	$	1,662	$	31,115		$	(491	)	$	39,470
The accompanying notes are an integral part of these statements.

Page Six

HIGHLANDS BANKSHARES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In Thousands of Dollars)
	Nine Months Ended September 30,
	2007			2006
	(unaudited)			(unaudited)
Cash Flows From Operating Activities
Net Income	$	3,377		$	3,361
Adjustments to reconcile net income to net
cash provided by operating activities
Depreciation		519			496
Increase in cash value of life insurance contracts		(173	)		(166	)
Net amortization of securities		(163	)		(112	)
Provision for loan losses		486			508
Amortization of intangibles		132			132
Decrease (increase) in interest receivable		(361	)		(226	)
Decrease (increase) in other assets		(429	)		(582	)
Increase in accrued expenses		325			550
Net Cash Provided by Operating Activities		3,713			3,961
Cash Flows From Investing Activities
Increase (decrease) in federal funds sold		(342	)		(97	)
Proceeds from maturities of securities available for sale		6,479			9,234
Purchase of securities available for sale		(10,827	)		(6,410	)
Proceeds from maturities of securities held to maturity					201
Increase in restricted investments		71			(198	)
Net change in interest bearing deposits in other banks		(1,759	)		(1,173	)
Settlement on insurance contract					555
Purchase of property and equipment		(428	)		(739	)
Net Change in Loans		(15,476	)		(13,554	)
Net Cash Used in Investing Activities		(22,282	)		(12,181	)
Cash Flows From Financing Activities
Net change in deposits		23,088			8,079
Additional long term debt		0			2,300
Repayment of long term debt		(2,727	)		(1,725	)
Dividends paid in cash		(1,078	)		(991	)
Net Cash Provided by Financing Activities		19,283			7,663
Net Increase (Decrease) in Cash and Cash Equivalents		714			(557	)
Cash and Cash Equivalents, Beginning of Period		7,111			8,850
Cash and Cash Equivalents, End of Period	$	7,825		$	8,293
Supplemental Disclosures
Cash paid for income taxes	$	2,315		$	1,766
Cash paid for interest	$	7,745		$	5,355
The accompanying notes are an integral part of these statements.

Page Seven

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1                      ACCOUNTING PRINCIPLES

The consolidated financial statements conform to U. S. generally accepted accounting principles and to general industry practices.  In the opinion of management, the accompanying unaudited consolidated financial statements contain all adjustments, consisting solely of normal recurring adjustments, necessary to present fairly the financial position as of September 30, 2007 and the results of operations for the three and nine-month periods ended September 30, 2007 and 2006.

The results of operations for the three and nine-month periods ended September 30, 2007 and 2006 are not necessarily indicative of the results to be expected for the full year.

The notes included herein should be read in conjunction with the notes to financial statements included in the Company’s 2006 annual report on Form 10-K.

Certain reclassifications have been made to prior period balances to conform to the current year’s presentation format.

NOTE 2                      SECURITIES AND RESTRICTED INVESTMENTS

The Company’s securities portfolio serves several purposes. Portions of the portfolio secure certain public and trust deposits while the remaining portions are held as investments or used to assist the Company in liquidity and asset/liability management.

The amortized cost and market value of securities held to maturity as of September 30, 2007 and December 31, 2006 are as follows (in thousands of dollars):

	September 30, 2007				December 31, 2006
	Amortized		Market		Amortized		Market
	Cost		Value		Cost		Value
Held to Maturity Securities
Obligations of states and municipalities	$	170	$	170	$	170	$	170
Total Held to Maturity Securities	$	170	$	170	$	170	$	170
Available For Sale Securities
U.S. Treasuries and Agencies	$	17,823	$	17,959	$	14,397	$	14,403
Mortgage backed securities		7,581		7,605		6,547		6,554
Obligations of states and municipalities		2,755		2,743		2,763		2,744
Marketable equities		28		28		28		28
Total Available For Sale Securities	$	28,187	$	28,335	$	23,735	$	23,729

Restricted investments consist of investments in the Federal Home Loan Bank, the Federal Reserve Bank and West Virginia Bankers’ Title Insurance Company.  Investments are carried at face value and the level of participation with each institution dictates the level of investment.  Amounts are restricted as to transferability. Investments in the Federal Home Loan Bank act as a collateral against the outstanding borrowings from that institution.

NOTE 3                      INVESTMENTS IN INSURANCE CONTRACTS

Investments in insurance contracts consist of single premium insurance contracts that have the dual purposes of providing a rate of return to the Company, which approximately equals the Company’s average cost of funds and of providing life insurance and retirement benefits to certain executives.

Page Eight

NOTE 4                      LOANS

A summary of loans outstanding as of September 30, 2007 and December 31, 2006 is shown in the table below (in thousands of dollars):

	September 30,		December 31,
	2007		2006
Loan Type
Commercial	$	81,837	$	70,408
Real Estate construction		15,738		14,828
Real Estate mortgage		165,153		164,243
Consumer installment		45,307		43,337
Total Loans	$	308,035	$	292,816

In addition to loans to fund construction and traditional mortgage loans, portions of the portfolio identified as commercial are also secured by real estate.  At September 30, 2007, the total balance of loans in the portfolio secured by real estate was $234,405,000.

NOTE 5                     ALLOWANCE FOR LOAN LOSSES

A summary of the transactions in the allowance for loan losses for the nine-month periods ended September 30, 2007 and 2006 is shown below (in thousands of dollars):

	2007			2006
Balance, beginning of period	$	3,482		$	3,129
Provisions charged to operations		486			508
Loan recoveries		283			171
Loan charge-offs		(540	)		(428	)
Balance, end of period	$	3,711		$	3,380

NOTE 6                      DEPOSITS

Balances of time deposits over $100,000 and of all other time deposits at September 30, 2007 and December 31, 2006 are shown below (in thousands of dollars):

	September 30,		December 31,
	2007		2006
Time deposits over $100,000	$	66,658	$	54,867
All other time deposits		137,952		127,301
Total Time Deposits	$	204,610	$	182,168

Interest expense for time deposits over $100,000 and for all other time deposits for the three and nine- month periods ended September 30, 2007 and 2006 is shown below (in thousands of dollars):

Nine Months Ended September 30,				Three Months Ended September 30,
2007		2006		2007		2006
$	2,243	$	1,423	$	818	$	537

Page Nine

NOTE 7                      EMPLOYEE BENEFITS

The Company's two subsidiary banks each have separate retirement and profit sharing plans, which cover substantially all full time employees at each bank.

Capon Valley Bank has a defined contribution pension plan with 401(k) features that is funded with discretionary contributions by the Bank.  The bank matches on a limited basis the contributions of the employees.  Investment of employee balances is done through the direction of each employee.  Employer contributions are vested over a six-year period.

The Grant County Bank is a member of the West Virginia Bankers' Association Retirement Plan.  Benefits under the plan are based on compensation and years of service with 100% vesting after seven years of service.  Prior to 2002, the Plan's assets were in excess of the projected benefit obligations and thus the Bank was not required to make contributions to the Plan in 2003, 2002 or 2001. The bank was required to make contributions in 2004, 2005 and 2006 and has made contributions to the plan during 2007.  The Bank has recognized liabilities of $692,000 at September 30, 2007 as a result of this shortfall.  The following table provides the components of the net periodic benefit cost for the plan for the nine-month periods ended September 30, 2007 and 2006 (in thousands of dollars):

	2007			2006
Service cost	$	100		$	94
Interest cost		160			138
Expected return on plan assets		(170	)		(152	)
Amortization of unrecognized prior service costs		8			8
Recognized net actuarial loss		48			43
Net periodic expense	$	146		$	131

NOTE 8                      DEBT INSTRUMENTS

The Company continues to borrow money from the Federal Home Loan Bank of Pittsburgh (FHLB) to meet specificfunding needs.  The interest rates of the notes payable as of September 30, 2007 range from 3.30% to 6.12%.  The weighted average interest rate was 4.39% at September 30, 2007. The debt is secured by the general assets of the Banks.

Page Ten

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

Forward Looking Statements

Certain statements in this report may constitute “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995.  Forward-looking statements are statements that include projections, predictions, expectations or beliefs about future events or results or otherwise are not statements of historical fact.  Such statements are often characterized by the use of qualified words (and their derivatives) such as “expect,” “believe,” “estimate,” “plan,” “project,” “anticipate” or other similar words.  Although the Company believes that its expectations with respect to certain forward-looking statements are based upon reasonable assumptions within the bounds of its existing knowledge of its business and operations, there can be no assurance that actual results, performance or achievements of the Company will not differ materially from any future results, performance or achievements expressed or implied by such forward-looking statements.  Actual future results and trends may differ materially from historical results or those anticipated depending on a variety of factors, including, but not limited to, the effects of and changes in:  general economic conditions, the interest rate environment, legislative and regulatory requirements, competitive pressures, new products and delivery systems, inflation, changes in the stock and bond markets, technology, downturns in the trucking and timber industries, effects of mergers and/or downsizing in the poultry industry in the Company’s geographic operating footprint, and consumer spending and savings habits.  Additionally, actual future results and trends may differ from historical or anticipated results to the extent: (1) any significant downturn in certain industries, particularly the trucking and timber industries are experienced; (2) loan demand decreases from prior periods; (3) the Company may make additional loan loss provisions due to negative credit quality trends in the future that may lead to a deterioration of asset quality; (4) the Company may not continue to experience significant recoveries of previously charged-off loans or loans resulting in foreclosure; and (5) the Company is unable to control costs and expenses as anticipated. The Company does not update any forward-looking statements that may be made from time to time by or on behalf of the Company. Additionally, consideration should be given to the cautionary language found elsewhere in this Form 10-Q and in the section on “Risk Factors” Item 1A in the Company’s Annual Report of Form 10-K for the year ended December 31, 2006.

Introduction

The following discussion focuses on significant results of the Company’s operations and significant changes in our financial condition or results of operations for the periods indicated in the discussion. This discussion should be read in conjunction with the preceding financial statements and related notes, as well as the Company’s Annual Report on Form 10-K for the period ended December 31, 2006.

Current performance does not guarantee, and may not be indicative of, similar performance in the future.

Critical Accounting Policies

The Company’s financial statements are prepared in accordance with accounting principles generally accepted in the United States (“GAAP”). The financial statements contained within these statements are, to a significant extent, financial information that is based on measures of the financial effects of transactions and events that have already occurred. A variety of factors could affect the ultimate value that is obtained either when earning income, recognizing an expense, recovering an asset or relieving a liability. In addition, GAAP itself may change from one previously acceptable method to another method. Although the economics of these transactions would be the same, the timing of events that would impact these transactions could change.

Disclosure of the Company’s significant accounting policies is included in Note Two to the Consolidated Financial Statements of the Company’s Annual Report on Form 10-K for the period ended December 31, 2006. Some of the policies are particularly sensitive, requiring significant judgments, estimates and assumptions by management.

Page Eleven

The allowance for loan losses is an estimate of the losses that may be sustained in the loan portfolio. The allowance is based on two basic principles of accounting: (i) SFAS No. 5, Accounting for Contingencies, which requires that losses be accrued when they are probable of occurring and estimable and (ii) SFAS No. 114, Accounting by Creditors for Impairment of a Loan, which requires that losses be accrued based on the differences between the value of collateral, present value of future cash flows or values that are observable in the secondary market and the loan balance. Additional information pertaining to the allowance for loan losses and provision for loan losses is contained on pages 16-18 of this report.

The Company has invested in and owns life insurance policies on certain officers. The policies are designed so that the company recovers the interest expenses associated with carrying the policies and the officer will, at the time of retirement, receive any earnings in excess of the amounts earned by the Company. The Company recognizes as an asset the net amount that could be realized under the insurance contract as of the balance sheet date. This amount represents the cash surrender value of the policies less applicable surrender charges. The portion of the benefits, which will be received by the executives at the time of their retirement, is considered, when taken collectively, to constitute a retirement plan. Therefore the Company accounts for these policies using guidance found in Statement of Financial Accounting Standards No. 106, "Employers' Accounting for Post Retirement Benefits Other Than Pensions.” SFAS No. 106 requires that an employers' obligation under a deferred compensation agreement be accrued over the expected service life of the employee through their normal retirement date. Assumptions are used in estimating the present value of amounts due officers after their normal retirement date.  These assumptions include the estimated income to be derived from the investments and an estimate of the Company’s cost of funds in these future periods.  In addition, the discount rate used in the present value calculation will change in future years based on market conditions.

During 2005, the Company purchased all the outstanding shares of the National Bank of Davis. The net assets of this purchase were recorded at fair value, including goodwill. Goodwill represents the cost in excess of the fair value of net assets acquired (including identifiable intangibles) in transactions accounted for as purchases.  In accordance with provisions of SFAS No. 142, "Goodwill and Other Intangible Assets", goodwill is not amortized over an estimated useful life, but rather will be tested at least annually for impairment. Core deposit and other intangible assets include premiums paid for acquisitions of core deposits (core deposit intangibles) and other identifiable intangible assets.  Intangible assets other than goodwill, which are determined to have finite lives, are amortized based upon the estimated economic benefits received.

Recent Accounting Pronouncements

In September 2006, the FASB issued Statement of Financial Accounting Standards No. 158, “Employers Accounting for Defined Benefit Pension and Other Postretirement Plans—an amendment of FASB Statements No. 87, 88, 106 and 132R” (SFAS 158). SFAS 158 requires an employer to recognize the over-funded or under-funded status of a defined benefit postretirement plan as an asset or liability in its statement of financial position and to recognize changes in that funded status, through comprehensive income, in the year in which the changes occur. The funded status of a benefit plan will be measured as the difference between plan assets at fair value and benefit obligation. For any other postretirement plan, the benefit obligation is the accumulated postretirement benefit obligation. SFAS 158 also requires an employer to measure the funded status of a plan as of the date of its year-end statement of financial position. The Statement also requires additional disclosures in the notes to financial statements about certain effects on net periodic benefit cost for the next fiscal year that arise from delayed recognition of the gains or losses, prior service costs or credits, and transition asset or obligation. Under SFAS 158 a company is required to initially recognize the funded status of a defined benefit postretirement plan to provide the required disclosures as of the end of the fiscal year ending after December 15, 2006. The requirement to measure plan assets and benefit obligations as of the date of the employer’s fiscal year end statement of financial position is effective for fiscal years ending after December 15, 2008. The Grant County Bank is a member of the West Virginia Bankers' Association Retirement Plan, a defined benefit plan under SFAS 158.

Page Twelve

In September of 2006, the Emerging Issues Task Force of the FASB (EITF) issued EITF 06-04. This pronouncement affects the recording of post retirement costs of insurance of bank owned life insurance policies in instances where the Company has promised a continuation of life insurance coverage to persons post retirement. EITF 06-04 requires that a liability equal to the present value of the cost of post retirement insurance be recorded during the insured employees’ term of service. The terms of this pronouncement require the initial recording of this liability with a corresponding adjustment to retained earnings to reflect the implementation of the pronouncement.  This EITF becomes effective for fiscal years ending after December 15, 2007, and as such Highlands Bankshares’ financial statements for the periods shown in this Quarterly Report on Form 10-Q do not reflect the recording of this liability. On January 1, 2008, Highlands Bankshares will record the appropriate liability and corresponding effect on retained earnings, and for periods after January 1, 2008 will record an appropriate liability and corresponding effects on current income for the applicable periods. At present, the exact effect of this pronouncement on Highlands retained earnings or current income for future periods has not been calculated.

No other recent accounting pronouncements had a material impact on the Company’s consolidated financial statements, and it is believed that none will have a material impact on the Company’s operations in future years.

Overview of Results

Net income for the first nine months of 2007 was .48% higher than the same period in 2006. A 6.86% increase in net interest income was offset by a slight decline in non-interest income and a 7.26% increase in non-interest expense.

Net interest income grew largely as the result of continued growth in average balances of earning assets compared to growth in interest bearing liabilities, although the effects of this relative growth were offset to some degree by increases in average rates on interest bearing liabilities being greater than the increases experienced in the average rates earned on earning assets.

During 2006, the Company recorded a one-time gain of $155,000 related to an insurance settlement (See Note Twenty of the Financial Statements included in the Company’s Annual Report on Form 10-K for the Year Ended December 31, 2006) This gain recorded in 2006 was the largest factor in contributing to the Company’s $29,000 decrease in other interest income for the first nine months of 2007 as compared to 2006. Service charge income continued to increase largely as a result of the growth of Company’s deposit base.

The increase in non-interest expense was largely the result of increases in the cost of employee salaries and benefits, increases in legal and professional fees, and the impact of continued operational growth on both occupancy and equipment expense and data processing expense.

Highlands' results of operations are discussed in greater detail following this overview. Unless otherwise specifically noted, the underlying causes for changes in the results for the quarter ended September 30, 2007 as compared to the same quarter in 2006 are substantially the same as the causes discussed for the nine months ended September 30, 2007 as compared to the nine months ended September 30, 2006.

Net Interest Income

Net interest income, on a fully taxable equivalent basis, increased 6.83% for the first nine months of 2007 as compared to the same period in 2006. This increase came primarily as the result of the relative size of increases in earning assets compared to increases in interest bearing liabilities, which was offset in part by the increase in the average rates paid on interest bearing liabilities compared to the increase average rate earned on earning assets.

The table on the following page illustrates the effects on net interest income, on a fully taxable equivalent basis, and for the first nine months of each year, of changes in average volumes of interest bearing liabilities and earning assets from 2006 to 2007 and changes in average rates on interest bearing liabilities and earning assets from 2006 to 2007 (in thousands of dollars):

Page Thirteen

EFFECT OF RATE-VOLUME CHANGES ON NET INTEREST INCOME
(On a fully taxable equivalent basis)
(In thousands of dollars)
Increase (Decrease) Nine Months Ended September 30, 2007 Compared to Nine Months Ended September 30, 2006
	Due to change in:
	Average Volume			Average Rate			Total Change
Interest Income
Loans	$	1,570		$	1,111		$	2,681
Federal funds sold		210			52			262
Interest bearing deposits		41			20			61
Taxable investment securities		(56	)		197			141
Nontaxable investment securities		(6	)		6			0
Total Interest Income		1,759			1,386			3,145
Interest Expense
Demand deposits		(1	)		2			1
Savings deposits		(28	)		133			105
Time deposits		978			1,331			2,309
Borrowed money		(98	)		16			(82	)
Total Interest Expense		851			1,482			2,333
Net Interest Income	$	908		$	(96	)	$	812

Increases by the Federal Reserve Board (“The Fed”) throughout 2005 and continuing into 2006 for the target rate for federal funds sold has caused both rates earned on assets and rates paid on liabilities to increase.  Although the increases by The Fed slowed in late 2006 and the Fed has cut rates during 2007, the Company’s balance sheet continues to be impacted by the increases enacted during 2005 and early 2006. As older earning assets and interest bearing liabilities mature and are replaced by newer earning assets and interest bearing liabilities, which bear higher rates of interest, the Company has experienced increases in both the average rates earned on assets and the average rates paid on liabilities

Due mainly to both the shorter maturities on deposits versus those on loans or securities investments, and the relative ratio of time deposits, typically a higher cost interest bearing liability, to other interest bearing liabilities, the average rates paid on interest bearing liabilities increased 81 basis points compared to a 52 basis point increase in average rates earned on assets.

Historically, the Company, in an effort to attract deposits with which to fund loan growth, has often paid rates on deposits higher than national averages. During the later portions of 2004 and during 2005, the Company chose to fund loan growth through reductions in deposit balances and also reductions of comparatively lower earning assets like federal funds sold and securities rather than compete for deposits based upon rate. As The Fed has continued to increase the target rate for federal funds sold, the average rates earned by securities, federal funds sold and deposits in other banks have increased more than the rates on loans. As such, Management has somewhat eased its strategy for funding loans through reductions in these lower earning assets because, in some instances, the rates paid on these assets are greater than the cost of interest on new deposits. In addition, strong loan demand throughout the later parts of 2006 and continuing into 2007 created a need for the offering of higher rates on deposits to attract new deposits with which to fund this loan growth. As such, the Company’s average rates paid on time deposits and average balances of time deposits have increased.

Page Fourteen

As of September 30, 2007, the Company had balances of liquid funds, mostly in the form of federal funds sold, greater than seen during previous recent years. Because of the larger balances of liquid funds, Management anticipates that, in the immediately upcoming quarters, the need for offering above market rates to attract new deposits will continue to lessen as compared to recent years, allowing net interest margins to continue at or near recent levels.

Although rate increases by the Fed in 2005 and 2006 have ceased, and during the third quarter of 2007 the Fed implemented decreases in the target rate for Federal Fund Sold, the Company anticipates that during the immediately upcoming quarters, its ability to manage its balance sheet of earning assets and interest bearing liabilities will have a greater impact on the Company’s net interest margin during these quarters than the effects of the rate decreases. Although the Company anticipates that the recently enacted rate decreases by the Fed will cause both the average rates paid on earning assets and interest bearing liabilities to decline, the current balances of liquid funds, in the form of federal funds sold and interest bearing deposits, will allow the Company enough funding flexibility such that no significant decreases in net interest margin are anticipated in the immediately upcoming quarters should loan demand remain strong.

The table below sets forth an analysis of net interest income for the nine-month periods ended September 30, 2007 and 2006 (Average balances and interest/expense shown in thousands of dollars):

	2007								2006
	Average			Income/					Average			Income/
	Balance			Expense		Rate			Balance			Expense		Rate
Interest Income
Loans1,2	$	300,905		$	18,830		8.34	%	$	274,230		$	16,149		7.85	%
Federal funds sold		15,715			600		5.09	%		9,695			338		4.65	%
Interest bearing deposits		2,490			100		5.35	%		1,216			39		4.28	%
Taxable investment securities		23,581			948		5.36	%		25,339			807		4.25	%
Nontaxable investment securities3		2,927			134		6.10	%		3,076			134		5.81	%
Total Earning Assets		345,618			20,612		7.95	%		313,556			17,467		7.43	%
Cash and cash equivalents		8,006								7,957
Allowance for loan losses		(3,626	)							(3,232	)
Insurance contracts		6,151								6,256
Non-earning assets		15,535								14,615
Total Assets	$	371,684							$	339,152
Interest Expense
Interest bearing demand deposits	$	25,528		$	168		.88	%	$	25,677		$	167		.87	%
Savings and money markets		47,744			507		1.42	%		51,288			402		1.05	%
Time deposits		194,156			6,783		4.66	%		159,320			4,474		3.74	%
Long term debt		12,841			447		4.64	%		15,779			529		4.47	%
Total Interest Bearing Liabilities		280,269			7,905		3.76	%		252,064			5,572		2.95	%
Demand deposits		48,249								47,968
Other liabilities		4,923								3,893
Stockholders’ equity		38,243								35,227
Total liabilities and stockholders’ equity	$	371,684							$	339,152
Net Interest Income				$	12,707							$	11,895
Net Yield on Earning Assets3							4.90	%							5.06	%

¹Balances of loans include loans in non-accrual status

²Interest income on loans includes fees

³Yields are on a fully taxable equivalent basis

Page Fifteen

The table below sets forth an analysis of net interest income for the three-month periods ended September 30, 2007 and 2006 (Average balances and interest/expense shown in thousands of dollars):

	2007								2006
	Average			Income/					Average			Income/
	Balance			Expense		Rate			Balance			Expense		Rate
Interest Income
Loans1,2	$	305,542		$	6,471		8.47	%	$	278,888		$	5,698		8.17	%
Federal funds sold		15,449			195		5.05	%		9,636			124		5.15	%
Interest bearing deposits		2,660			30		4.51	%		1,497			16		4.28	%
Taxable investment securities		25,792			354		5.49	%		23,620			276		4.67	%
Nontaxable investment securities3		2,860			46		6.43	%		2,858			42		5.88	%
Total Earning Assets		352,303			7,096		8.06	%		316,499			6,156		7.78	%
Cash and cash equivalents		7,950								8,015
Allowance for loan losses		(3,693	)							(3,330	)
Insurance contracts		6,205								5,976
Nonearning assets		16,518								15,010
Total Assets	$	379,283							$	342,170
Interest Expense
Interest bearing demand deposits	$	24,358		$	55		.90	%	$	25,218		$	55		.87	%
Savings and money markets		49,278			191		1.55	%		48,696			139		1.14	%
Time deposits		201,223			2,406		4.78	%		164,822			1,679		4.04	%
Long term debt		12,416			144		4.61	%		15,781			174		4.41	%
Total Interest Bearing Liabilities		287,275			2,796		3.89	%		254,517			2,047		3.22	%
Demand deposits		47,435								47,930
Other liabilities		5,550								3,477
Stockholders’ equity		39,023								36,246
Total liabilities and stockholders’ equity	$	379,283							$	342,170
Net Interest Income				$	4,300							$	4,109
Net Yield on Earning Assets3							4.88	%							5.19	%
1Balances of loans include loans in nonaccrual status
2Interest income on loans includes fees
3Yields are on a fully taxable equivalent basis

Page Sixteen

Loan Portfolio

The Company is an active residential mortgage and construction lender and generally extends commercial loans to small and medium sized businesses within its primary service area.  The Company's commercial lending activity extends across its primary service areas of Grant, Hardy, Hampshire, Mineral, Randolph, Tucker, and northern Pendleton counties in West Virginia, Frederick County, Virginia and Garrett County, Maryland.  Consistent with its focus on providing community-based financial services, the Company does not attempt to diversify its loan portfolio geographically by making significant amounts of loans to borrowers outside of its primary service area.

Credit Quality and Allowance for Loan Losses

Non-performing loans increased 41.45% from December 31, 2006 to September 30, 2007. Non-performing loans represented .78% of gross loans at September 30, 2007 and .58% of gross loans at December 31, 2006. The increase in non-performing loans was the result of the decline in quality of a few larger loans. As potential impairments on these loans have been considered by Management in the Company’s allowance for loan loss, no further loss not already allowed for is anticipated. In addition, because this increase is the result of a few larger loans, management believes that the increase in non-performing loans is not indicative of a growing trend of deterioration of quality in its loan portfolio.

The following table summarizes the Company’s non-performing loans at September 30, 2007 and December 31, 2006 (in thousands of dollars):

	September 30,		December 31,
	2007		2006
Non-accrual loans	$	1,371	$	244
Loans past due 90 days and still accruing interest		1,035		1,457
Total non-performing loans	$	2,406	$	1,701

Non-performing loans include non-accrual loans, loans 90 days or more past due and restructured loans. Non-accrual loans are loans on which interest accruals have been suspended or discontinued permanently.  Restructured loans are loans on which the original interest rate or repayment terms have been changed due to financial hardship of the borrower.

Loans are typically placed on non-accrual status once they have reached certain levels of delinquency, depending on loan type, and it is no longer reasonable to expect collection of principal and interest because collateral is insufficient to cover both the principal and interest due. After loans are placed on non-accrual status, they are returned to accrual status if the obligation is brought current by the borrower, or they are charged off if payment is not made and Management believes that collection of the amounts due is doubtful. Charged-off loans are charged against the allowance for loan losses. Any subsequent collection or sale of repossessed collateral is typically added to the allowance as a recovery.

Because of its large impact on the local economy, Management continuously monitors the economic health of the poultry industry.  The Company has direct loans to poultry growers and the industry is a large employer in the Company’s trade area.  The Company’s loan portfolio also reflects a concentration in loans collateralized by heavy equipment, particularly in the trucking and timber and coal extraction industries. In part because of rising fuel costs, and because of continued slow economic growth, the trucking sector experienced a recent downturn, and profitability growth within this sector still appears to be sluggish. While close monitoring of this sector is necessary, management expects no significant losses in the foreseeable future.

An inherent risk in the lending of money is that the borrower will not be able to repay the loan under the terms of the original agreement.  The allowance for loan losses provides for this risk and is reviewed periodically for adequacy.  This review also considers concentrations of loans in terms of geography, business type or level of risk.  While lending is geographically diversified within the service area, the Company does have some concentration of loans in the area of agriculture (primarily poultry farming), timber and related industries. Management recognizes these concentrations and considers them when structuring its loan portfolio.

Page Seventeen

Each of the Company's banking subsidiaries, Capon Valley Bank and The Grant County Bank, determines the adequacy of its allowance for loan losses independently. Although the loan portfolios of the two banks are similar to each other, some differences exist which result in divergent risk patterns and different charge-off rates amongst the functional areas of the banks’ portfolios.  Each bank pays particular attention to individual loan performance, collateral values, borrower financial condition and economic conditions.  The determination of an adequate allowance at each bank is done in a three-step process.  The first step is to identify impaired loans. Impaired loans are problem loans above a certain threshold, which have estimated losses calculated based on collateral values and projected cash flows.  The second step is to identify loans above a certain threshold, which are problem loans due to the borrower’s payment history or deteriorating financial condition.  Losses in this category are determined

based on historical loss rates adjusted for current economic conditions.  The final step is to calculate a loss for the remainder of the portfolio using historical loss information for each type of loan classification. The determination of specific allowances and weighting is somewhat subjective and actual losses may be greater or less than the amount of the allowance.  However, Management believes that the allowance represents a fair assessment of the losses that exist in the current loan portfolio.

The required level of the allowance for loan losses is computed quarterly and the allowance adjusted prior to the issuance of the quarterly financial statements.  All loan losses charged to the allowance are approved by the boards of directors of each bank at their regular meetings.  The allowance is reviewed for adequacy after considering historical loss rates, current economic conditions (both locally and nationally) and any known credit problems that have not been considered under the above formula.

Management has analyzed the potential risk of loss on the Company's loan portfolio given the loan balances and the value of the underlying collateral and has recognized losses where appropriate. Non-performing loans are closely monitored on an ongoing basis as part of the Company's loan review process.

The following table shows the allocation for loans in the loan portfolio and the corresponding amounts of the allowance allocated by loan type as of September 30, 2007 and December 31, 2006 (in thousands of dollars):

	September 30, 2007					December 31, 2006
			Percent of					Percent of
	Amount		Loans			Amount		Loans
Loan Type
Commercial	$	1,467		26	%	$	1,492		24	%
Mortgage and construction		1,010		59	%		996		61	%
Consumer		1,135		15	%		967		15	%
Unallocated		99					27
Totals	$	3,711				$	3,482

As certain loans identified as impaired are paid current, collateral values increase or loans are removed from watch lists for other reasons, and as other loans become identified as impaired, and because delinquency levels within each of the portfolios change, the allocation of the allowance among the loan types may change. Management feels that the allowance is a fair representation of the losses present in the portfolio given historical loss trends, economic conditions and any known credit problems as of a given date. Management believes that the allowance is to be taken as a whole, and allocation between loan types is an estimation of potential losses within each type given information known at the time.

Page Eighteen

The following table summarizes the Company’s net charge-offs by loan type for the nine-month periods ended September 30, 2007 and 2006 (in thousands of dollars):

	2007			2006
Charge-offs
Commercial	$	(141	)	$	(27	)
Mortgage and construction		(38	)		(1	)
Consumer		(361	)		(402	)
Total Charge-offs		(540	)		(430	)
Recoveries
Commercial		50			4
Mortgage		4			0
Consumer		229			169
Total Recoveries		283			173
Total Net Charge-offs	$	(257	)	$	(257	)

The provision for loan losses taken during the first nine months of 2007 was $22,000 less than that taken during the same period in 2006. In spite of the decrease in the provision, the ratio of the allowance for loan losses to gross loans increased from 1.19% at December 31, 2006 to 1.20% at September 30, 2007.   At September 30, 2006, the ratio of the allowance for loan losses to gross loans was 1.19%.  The ratio of allowance for loan losses to non-performing loans was 1.54 at September 30, 2007 compared to 2.05 at December 31, 2006.

Non-interest Expense

Non-interest expense increased 7.26% for the first nine months of 2007 as compared to the same period in 2006.

As the relative size of the Company’s operations continued to increase, the Company’s cost of equipment and also data processing expense also increased. Legal and professional fees increased $65,000 as compared to 2006 largely as a result of increased on-site engagements of consultants assisting the Company with Sarbanes Oxley Rule 404 compliance.

The cost of employee salaries and related benefits increased 5.75% as normal annual increases in pay and increases in the number of full time equivalent employees employed by the Company and its subsidiaries were coupled with a slight increase in the cost of postretirement benefit plans.  The table below summarizes the effects of increases in average pay per employee, increases in the number of full time equivalent employees and changes in the cost of post retirement benefits for employees on changes in the cost of salaries and employee benefits from 2006 to 2007 (in thousands of dollars):

	Amount
Increase in cost due to increases in average rate of employee salaries and benefits	$	82
Increase in cost of employee salaries and benefits due to increases in full time equivalent employees		129
Increase in costs related to post retirement benefits		32
Total Increase in cost of employee salaries and benefits	$	243

Page Nineteen

Borrowed Funds

The Company borrows funds from the Federal Home Loan Bank (“FHLB”) to reduce market rate risks, provide liquidity, and to fund capital additions.  These borrowings may have fixed or variable interest rates and are amortized over a period of one to twenty years, or may be comprised of single payment borrowings with periodic interest payments and principal amounts due at maturity. In an attempt to manage interest expense and interest rate risk and as competition for deposits have increased, the Company has, during recent periods, used these available debt vehicles to fund loan growth more frequently than was utilized in the past.

Liquidity

Operating liquidity is the ability to meet present and future financial obligations. Short-term liquidity is provided primarily through cash balances, deposits with other financial institutions, federal funds sold, non-pledged securities and loans maturing within one year. Additional sources of liquidity available to the Company include, but are not limited to, loan repayments, the ability to obtain deposits through the adjustment of interest rates and the purchasing of federal funds.  To further meet its liquidity needs, the Company also maintains lines of credit with correspondent financial institutions, the Federal Reserve Bank of Richmond and the Federal Home Loan Bank of Pittsburgh.

Historically, the Company’s primary need for additional levels of operational liquidity has been to fund increases in loan balances. The Company has normally funded increases in loans by increasing deposits and decreases in secondary liquidity sources such as balances of federal funds sold and balances of securities. In recent periods, the Company has substantially maintained or increased levels of these secondary liquidity resources and does not anticipate that an unexpectedly high level of loan demand in coming periods would impact liquidity to the extent that the Company would be required to pay above market rates to obtain deposits.

The parent Company’s operating funds, funds with which to pay shareholder dividends and funds for the exploration of new business ventures, have been supplied primarily through dividends paid by the Company’s subsidiary banks Capon Valley Bank (CVB) and The Grant County Bank (GCB).  The various regulatory authorities impose restrictions on dividends paid by a state bank.  A state bank cannot pay dividends without the consent of the relevant banking authorities in excess of the total net profits of the current year and the combined retained profits of the previous two years.  As of October 1, 2007, the subsidiary banks could pay dividends to Highlands Bankshares, Inc. of approximately $8,032,000 without permission of the regulatory authorities.

Page Twenty

Capital

The Company seeks to maintain a strong capital base to expand facilities, promote public confidence, support current operations and grow at a manageable level.  As of September 30, 2007, the Company was above the regulatory minimum levels of capital. The table below summarizes the capital ratios for the Company and its subsidiary banks as of September 30, 2007 and December 31, 2006:

	September 30, 2007						December 31, 2006
	Actual			Regulatory			Actual			Regulatory
	Ratio			Minimum			Ratio			Minimum
Total Risk Based Capital Ratio
Highlands Bankshares		14.32	%		8.00	%		13.45	%		8.00	%
Capon Valley Bank		14.51	%		8.00	%		14.56	%		8.00	%
The Grant County Bank		13.15	%		8.00	%		12.63	%		8.00	%
Tier 1 Leverage Ratio
Highlands Bankshares		9.85	%		4.00	%		9.26	%		4.00	%
Capon Valley Bank		9.87	%		4.00	%		9.53	%		4.00	%
The Grant County Bank		9.06	%		4.00	%		8.85	%		4.00	%
Tier 1 Risk Based Capital Ratio
Highlands Bankshares		13.09	%		4.00	%		12.21	%		4.00	%
Capon Valley Bank		13.26	%		4.00	%		13.30	%		4.00	%
The Grant County Bank		11.92	%		4.00	%		11.39	%		4.00	%

Effects of Inflation

Inflation primarily affects industries having high levels of property, plant and equipment or inventories. Although the Company is not significantly affected in these areas, inflation does have an impact on the growth of assets.  As assets grow rapidly, it becomes necessary to increase equity capital at proportionate levels to maintain the appropriate equity to asset ratios.  Traditionally, the Company's earnings and high capital retention levels have enabled the Company to meet these needs. The Company's reported earnings results have been minimally affected by inflation.  The different types of income and expense are affected in various ways.  Interest rates are affected by inflation, but the timing and magnitude of the changes may not coincide with changes in the consumer price index.  Management actively monitors interest rate sensitivity in order to minimize the effects of inflationary trends on interest rates. Other areas of non-interest expenses may be more directly affected by inflation.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

There have been no material changes in Quantitative and Qualitative Disclosures about Market Risk as reported in the Company’s Annual Report on Form 10-K for the period ended December 31, 2006.

Item 4. Controls and Procedures

The Company’s management, with the participation of the Company’s Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of the Company’s disclosure controls and procedures as of September 30, 2007. Based on this evaluation, the Company’s Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures are effective as of September 30, 2007. The company has established procedures undertaken during the normal course of business in an effort to reasonably ensure that fraudulent activity of either an amount material to these results or in any amount is not occurring.

Changes in Internal Controls

During the period reported upon, there were no significant changes in internal controls of Highlands Bankshares, Inc. pertaining to its financial reporting and control of its assets or in other factors that materially affected or are reasonably likely to materially affect such control.

Page Twenty One

Item 4T. Controls and Procedures

Not applicable.

PART II OTHER INFORMATION

Item 1. Legal Proceedings

Management is not aware of any material pending or threatened litigation in which the Company or its subsidiaries may be involved as a defendant.  In the normal course of business, the banks periodically must initiate suits against borrowers as a final course of action in collecting past due loans. In addition, to management’s knowledge, no governmental authorities have initiated or contemplated legal action against the Company.

Item 1A. Risk Factors

There have been no material changes to the Company’s risk factors since these factors were previously disclosed in the Company’s Annual Report on Form 10-K for the period ended December 31, 2006.

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

None

Item 3.           Defaults Upon Senior Securities

None

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

None

Item 5.           OtherInformation

None

Item 6.           Exhibits

3(i)	Restated Articles of Incorporation of Highlands Bankshares, Inc, as amended
3(ii)	Bylaws of Highlands Bankshares, Inc. are incorporated by reference to Exhibit 3(ii) to Highlands Bankshares, Inc.’s Report on Form 10-Q for the quarter ended March 31, 2003.
31.1	Certification of Chief Executive Officer Pursuant to section 302 of the Sarbanes-Oxley Act of 2002 Chapter 63, Title 18 U.S.C. Section 1350 (A) and (B).
31.2	Certification of Chief Financial Officer Pursuant to section 302 of the Sarbanes-Oxley Act of 2002 Chapter 63, Title 18 U.S.C. Section 1350 (A) and (B).
32.1	Statement of Chief Executive Officer Pursuant to 18  U.S.C. § 1350.
32.2	Statement of Chief Financial Officer Pursuant to 18  U.S.C. § 1350.

Page Twenty Two

Signatures

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

	HIGHLANDS BANKSHARES, INC.
	/s/ C.E. Porter
	C.E. Porter
	President & Chief Executive Officer
	/s/ R. Alan Miller
	R. Alan Miller
	Chief Financial Officer
November 13, 2007